Schaeffer's Trading Floor Blog

Tips on Trading VIX Options

Examining ways to play the VIX as it drifts lower

by 5/20/2014 7:35 AM
Stocks quoted in this article:

We all know the market's churning and the CBOE Volatility Index (VIX) is drifting. So, how should you play VIX options? Steven Sears takes up the topic in this week's Striking Price:

Jim Strugger, MKM Partners' derivative strategist, told clients that one-month at-the-money VIX options volatility were around 40 on Monday, very near the December 2013 level that is the absolute low since VIX options began trading in 2004.

Credit Suisse is likewise telling clients that this means that VIX options are near their cheapest ever. The firm's strategists are advising clients to buy VIX options in anticipation that volatility will increase.

If you are bearish on stocks, Credit Suisse recommends buying VIX June 15 calls and selling VIX June 20 calls. The call spread cost 75 cents when VIX futures were at 14.70 and covers the May 25 Ukraine election, and the next European Central Bank decision in June. On Monday, one investor bought 40,000 June 18 calls, paying 60 cents to 64 cents per call.

I certainly can't argue with the timing. VIX itself is pretty close to the lows of the last eight years. The implied volatility of VIX (proxied by the VVIX) continues to generally drift as well.

But on the other hand, VIX options price off VIX futures. And though they're modestly drifting lately, the futures curve still slopes upward and still overprices the probability of futures volatility lifts. Below is how the term structure looks now vs. how it looked on Jan. 21, when VIX itself was about where it is now, and the "Emerging Market Sell-Off Scare" hadn't quite hit our shores yet.

VIX futures since Jan. 21, 2014
Chart courtesy of VIX Central

The outer months have declined a bit, but you'd have to squint to notice much difference in the early cycles. As Credit Suisse mentions above, the June futures carry about a 2-point premium to "cash" VIX. So you have to first make that up in VIX itself.

Now again, I do like the idea conceptually. I doubt VIX itself goes much lower (bold call, I know) and it can make up the 2-point premium if Putin sneezes anywhere near the Ukraine border. And I almost always like out-of-the-money (OOTM) spreads better than straight OOTM call buys. I see any potential volatility lift as more of a blip than a permanent repricing.

I would just reiterate that you're "buying" VIX at 14.80, not 12.80, and timing is money. The European Central Bank decision and the Ukraine elections are known events that are baked into the pricing structures. The fact that prices are low indicates the market is either already discounting the results or not particularly worried about either outcome in either case. Volatility pops tend to happen off surprise events, not ones we see coming.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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