What a difference a day makes. As we discussed in the last Volatile Compounds (May 8th), we’d recently been seeing levels of volatility that we haven’t seen in decades. In early May the VIX danced below 10 for several days, historically low levels, amidst a market that seemed to go sideways or slightly higher every day, never even threatening a 1% intraday move in either direction. Even once we saw a few red days in the market, the VIX didn’t seem too bother, getting back above 10 but not really off the mat in any significant way.
Yesterday’s selling seems to have woken some vol buyers. Even with the market bouncing a bit today the VIX remains above 14, which indicates we’re probably done with a 10 VIX, for now.
Since this post is intended as a look at vol as an asset class, let’s check in on our two favorite plays for short and long VIX.
First, the XIV (the short term VIX futures short). As we’ve discussed, the XIV does well wen the market is sedate. It’s typically in contango (front month futures lower than the next month), and when that’s the case, it collects a little on the roll each day. Similar to being short premium in a stock. Of course, as we’ve discussed, the ideal time to own XIV is towards the end ofa period of backwardation, right before it goes back to contango. In those cases you benefit both from vol falling (and XIV rising) but also the collection of the difference on the roll each day after it crosses from backwardation to contango.
Even with the massive move in the VIX yesterday, the futures didn’t slip into backwardation. But it is close and therefore depends what happens in the near term, and june futures continue to spike. Or course, owning the XIV isn;t entirely about collecting from contango, it also has wild swings when the VIX has wild swings. Let’s look at how much it corrected yesterday based on a 1 year chart:
Pretty significant. But without a follow through the downside in the markets today, it hasn’t really threatened the lows we saw in April. Of course, you string a couple of days like yesterday together and it’s not unheard of for XIV to be down 30-40%. The best way to think of this is as a short premium trade. You collect a little bit each day and are practically guaranteed to make money over time, but on those occasions where the market wants to make a move lower, vol spikes, and XIV gets a big chunk cut out. As far as what’s next for XIV? There’s no hurry here to jump in unless you feel strongly that the selloff was a one day event. If we see any follow through in the next week or so we could easily see the VIX in the high teens, an that would likely mean XIV at 60 or below.
Now let’s flip to long vol and look at the long VIX futures through options strategy we detailed when the VIX was below 10. Here were the trade ideas:
VIX (9.70) zero cost risk reversals:
- Sell 1 July 12 put at .70
- Buy 1 July 15 call for 1.40
- Sell 1 July 20 call at .70
or for those looking to be there for a little bit more of a home run:
- Sell 1 July 12 put at .70
- Buy 1 July 17 call for 1.05
- Sell 1 July 27 call at .35
With VIX 14.50 these are up with the July futures. (July Futures are 14.25). But there’s really no hurry to manage these trades in any way. Their big payoffs come above 15 and 17 respectively. What’s good is this move higher i vol puts some distance between the futures above 14 and the July 12 put. Below 12 is the risk in these trades with a settlement around 10 meaning a 2 dollar loss. Of course, as we’ve seen, the VIX at or below 10 is rare, and it doesn’t take much to get it back towards the mid teens. That’s why we really like this trade structure when the VIX is low.