Name That Trade – $VIX: Rubbed

by Enis November 7, 2014 2:24 pm • Commentary

I discussed the global volatility backdrop in this morning’s post, with the following conclusion:

Given the overall macro backdrop, the subdued volatility in U.S. equity indices is likely related to year-end dynamics as we approach the holiday season.  Thanksgiving is less than 3 weeks away, and most traders and investors have positioned their portfolios accordingly into the end of the year with no major changes planned.  Unless a major surprise takes place to jar market participants into action, the impact of global volatility on U.S. equities is likely going to be bottled up until the start of 2015.

With earnings season out of the way, the overall feel in the market has returned to the slow grind higher than has characterized much of the past 2 years.  A big driver of that environment is corporate buybacks.  Buybacks are back in force for most of the large caps in the U.S., since the pre-earnings season blackout period is now over.  As a result, relentless corporate buying is likely to continue to dampen volatility barring an external shock.

However, looking to 2015, currency volatility is likely here to stay given the central bank policies around the world.  In addition, recent commodity volatility has added an extra variable.  With that in mind, we wanted to look at possible VIX options structures that target the start of 2015.  

Our first thought was that VIX spot should rise quickly after the new year as traders become more active at the turn of the calendar.  However, the issue with trying to put on a Jan15 VIX options structure right now is that the Jan15 VIX future is still priced at 16.40.  Here is the full VIX futures term structure:

[caption id="attachment_47821" align="alignnone" width="410"]VIX term structure, courtesy of Bloomberg VIX term structure, courtesy of Bloomberg[/caption]

As a result, Jan15 VIX options are priced off of that Jan15 VIX future level of 16.40, making it difficult to find a good risk/reward trade in the options at this juncture.

For example, selling the Jan15 14 put and buying the Jan15 18/22 call spread is around even money (no upfront premium) at the moment.  That is much worse than many of the VIX structures that we have done over the past year, when we could usually buy the 15/19 or 16/20 call spread for even money by selling the 14 or even sometimes the 13 put.

Granted, part of that reduced risk/reward reflects the fact that traders are more expectant of volatility today after the moves in October, compared to most of the past 2 years.  However, with the aforementioned holiday season approaching, our preferred strategy is to wait it out and be patient with the Jan15 and Feb15 VIX futures.  If Jan15 VIX futures fall to around 15, then we might revisit a possible VIX trade.