Is Now a Good Time to Buy CBOE Volatility Index (VIX) Calls?

The CBOE Volatility Index (VIX) has come back down to earth after a quick trip to overbought territory

Jul 30, 2015 at 9:28 AM
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The CBOE Volatility Index (VIX) got overbought and immediately came back down, and all I got was this lousy T-shirt. What should I do now?

Glad you asked. CNBC has the answer:

"But as the VIX tends to see massive swings higher and lower, buying it outright could prove dangerous, according to options expert Andrew Keene.

'I don't want to outright get long the VIX because I think [in the long run] the market can move higher and the VIX could move lower,' said the founder of Keene on the Market.

Instead, for those worried about a stock market correction, Keene recommended buying VIX call options as a means for protection."

Well, it's not the most radical idea I've ever heard, but it's also not the worst idea right now, either ... and I can't believe I'm typing that, as VIX calls are perpetually overpriced. So, let me state it another way: VIX calls are less overpriced than I would expect here.

Here's the CBOE VVIX Index (VVIX):


What's VVIX, you ask? It's the VIX methodology applied to VIX options. It shot up to 117 on the late-June VIX blast, then again to 100 just a few days ago. It's now back in the low 80s, modestly subnormal for 2015. In English, that means VIX options prices are on the lower end of normal already, a mere two days after the culmination of a pretty ugly market week.

And VIX options are really only about out-of-the-money (OOTM) VIX calls; thus, it's fair to infer that VIX call prices have gotten hit pretty hard this week, between the absolute move in VIX and the drop in VIX volatility.

Now, it's important to note that much of this is self-fulfilling. The VIX options board has a steep positive skew to it, thanks to that perpetual VIX OOTM call bid. Thus, VIX itself dropping causes the VVIX calculator to assign higher weight to lower VIX strikes -- and those lower VIX strikes carry lower implied volatility.

But, that same lowering of VIX, of course, lowers the absolute prices of all the calls. So it's tough to make the case that it's not a better time to buy them now than it was a few days ago.

Long story short, those VIX calls always overprice the probability of a VIX-plosion, so in a sense it's never right to own them. But the reality is that the next guy's going to overpay for them, too. And the drop this week is a bit steeper than normal. I'd rather fade into this than chase, given the nature of the churning markets of 2015.

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


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