After a string of success, our most recent trade in the VIX was a loser (full post here). However, the process behind this trade is more important than its most recent outcome. We hit an extraordinarily low volatility period and in hindsight should have closed the position once that fact started to become clear. However, the structure is one that has generally worked well for us over the past year and the low volatility in the market allows for a pretty good entry once again.
In my very first post on RiskReversal more than 2 years ago, I wrote the following on this topic:
Over time, we should focus on putting on good trades, not solely judging the trade by whether it made money or not. I learned that I shouldn’t be looking for the next Chapparal Steel, but I also shouldn’t be in constant worry over the next Monsanto. Rather, I should focus on the process of good trade selection, and trust that the odds in my favor should work out in the long run.
One bad trade is not going to change our mind about what we view as a high probability structure, especially when VIX futures are in the low teens. However, the crucial issue for our VIX trades have been timing. We got dinged on the last one as VIX spot settled near its all-time lows despite the FOMC meeting on June 18th.
In any case, we still like the structure of selling a VIX put and buying a VIX call spread for no premium or close to that level, because the fact is the trade only needs one VIX spike between initiation and expiration to become a nice winner. Over time, we have made money on this trade, even with last week’s nasty loss, and given our overall view that the market is overly complacent here, and VIX futures are near all-time lows, we especially like the entry today.
As for timing, while volatility could pick up at any time, we’d rather give ourselves more time on this entry, especially since SPX realized volatility remains below 10 (though it has picked up in the past week).
September VIX futures are even below 15 at this point:
[caption id="attachment_42217" align="alignnone" width="600"]
Sept VIX future daily chart, Courtesy of Bloomberg[/caption]
That is our favorite expiry for this trade since the summer will be over and all traders will be back at their desks. In addition, while it didn’t matter in June, we still like the fact that Sept VIX expiry is on the day of the Sept FOMC – at the least, it’s better than having no events near VIX expiration, though we certainly won’t rely on it for a favorable settlement any more.
TRADE – Sell the VIX (11.96) Sept 13 put and buy the Sept 15/19 call spread for a 0.10 debit
– Sell 1 Sept 13 put at 0.65
– Buy 1 Sept 15 call for 1.50
– Sell 1 Sept 19 call at 0.75
Break-Even on Sept Expiration:
-Profits up to 3.90 between 15.10 and 19, max profit of 3.90 at 19 or above
-Loss of 0.10 between 13 and 15, structure expires
-Further losses below 13 in linear fashion
Trade Rationale: This trade structure only loses more than 0.10 on a VIX print below 13 on September expiration. Our plan, as usual, would be to sell this structure if Sept VIX futures move into the high teens or near 20 at some point over the next 2.5 months. We will be especially vigilant about covering the 13 put on a bounce given our loss on the last VIX trade. For those who do not want to be naked short the Sept 13 put, one could buy the Sept 12 put for around 0.25, or the Sept 11 put for around 0.10.