Traders could play the VIX or the SPY to hedge against a broad-market dip
So, the market has recouped a good chunk of its losses since August, the CBOE Volatility Index (VIX) is back to a 16 full, and you want to hedge and/or play for some downside. What to do?
Well, you can "buy" the VIX. Except like almost always, you can't actually "buy" VIX at the price of VIX you see on the screen. The futures curve looks like this right now:
It's morphing back into the garden-variety upslope we've known and loved. So, sure, you can buy Octobers for $17.20. That sounds good enough -- except they expire in two weeks, so all you accomplish is betting on a relatively quick pop… and you're already 0.75 above the current VIX. There are VIX weeklys now, so you can go closer and shorter too. That's all great if VIX stops now, but doesn't do much to protect a portfolio -- it's just a spec bet that requires good timing.
I'd rather have more time, but that's going to cost more money. Long story short, none of this appeals to me.
But then I had a radical thought. What about actual SPDR S&P 500 ETF Trust (SPY) or S&P 500 Index (SPX) options? They all trade with actual implied volatilities that reflect… actual current implied volatility levels! Wow!
OK, I'm being sarcastic. I'd almost always rather just use actual put options or put spreads and "bet" on an actual index. Here's a play from last Friday along those lines from Michael Khouw on CNBC:
"To hedge against a potential turn in the recent rally, Khouw suggested buying a put spread in the S&P 500 ETF, the SPY. Specifically, he looked to purchase the December 200/184 put spread for a total cost of $4.45."
I totally agree with the concept, and I like the timing as well. I'm not predicting we give the downside another test, but IF we do, I'd guess November as to the timing. Just feels like in past cases, the down cycles amidst longer-term upcycles took about three months to play out. So I'd go with December cycle to play it.
The only place I'd really differ is I'd use a tighter strike on the sell side. I'd rather do something like a 200/190 spread and pay less of a debit. Either that or just a straight put buy. I just feel that if it gets back in the low 190s/ high 180s, the out-of-the-money vol is going to spike disproportionately. But that's as much personal preference as anything else; I like the trade.
Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.