VIX Plunge Presents Opportunity for Options Traders

The Cboe Volatility Index recently hits its lowest point since late 2019

Senior Quantitative Analyst
Dec 13, 2023 at 8:00 AM
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A few weeks back, I discussed the eight-day losing streak for the Cboe Volatility Index (VIX).That article included the table below, which shows how the S&P 500 Index (SPX) reacted after those losing streaks.

This table has been updated with the two-week and one-month returns after that latest streak, and it shows stocks have been great since then. Since that signal last month, the SPX is up more than 5%. The table shows two other times when the index rose at least 5% over the next month. Stocks kept charging higher after October 2011, but the time before that was in February 2010, and stocks moved lower that signal.

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Using options on the SPX, the VIX measures the 30-day implied volatility of the index. Since my article about a month ago, the VIX has continued to decline, hitting its lowest point since late 2019. SPX options are presently reflecting minimal expected volatility, rendering options on the SPX exceptionally cheap.

This made me wonder if there has been an ideal VIX level for option buying. This week, I’m examining whether SPX options have been more profitable when they’re extremely cheap in expectation of low volatility, or whether these low expectations align with the market’s subsequent behavior.

Returns Based on VIX Level

For this analysis, I went back to 2017 and grouped the dates by VIX level I created five groups, so they had an equal number of dates. Then I found the SPX return during the next month.

The table below shows the VIX range of each group and a summary of the subsequent one-month SPX returns. The VIX is currently in that very first group, where the lowest levels reside. The SPX has had better than average returns at these VIX levels. 

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The primary focus of this study was not centered on the performance of the SPX itself, but on understanding the typical performance of options. For this, I focused on options on the SPDR S&P 500 ETF Trust (SPY), which are extremely liquid.

First, I’m looking at straddles, a strategy that involves the simultaneous purchase of an at-the-money call and put. This approach eliminates the impact of market direction, since it provides a clear evaluation of whether option prices were undervalued, overvalued, or appropriately priced, based on subsequent market movements.

Note that to get one-month straddle returns for each day, I created hypothetical options that were exactly at-the-money, and expired in exactly 21 trading days (about a month). Option prices were found using actual implied volatilities at the time.

The data below suggests buying options when the VIX is low is preferable to when it’s high. SPY straddles have been very profitable when the VIX has been at 16.09 or lower. In that first VIX range (VIX between 9.14 and 12.81), buying straddles on the SPY would have returned 15% per trade, with just under half of the trades positive. Plus, 13% of the straddles would have doubled, which is the highest percentage of all the groupings.

The highest average return is in the next range up (VIX between 12.82 and 16.09). The straddles averaged about 25% per trade at these VIX levels, with 53% of those returns positive. The three groups with higher VIX levels had negative average straddle returns. This tells us options have been more profitable at cheaper prices going back to 2017.

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Finally, these last two tables break down the call and put returns separately. Calls have been better than puts as the SPX has trended upward. In fact, it has more than doubled since 2017, with an annualized return of about 15%. Buying calls at these extremely low VIX levels would have been especially profitable.

At VIX levels below 12.81, one-month calls on the SPY have averaged a gain of 62.5%, with 61% positive, and an impressive 35% doubling. Puts performed poorly at these low VIX levels, averaging a loss of more than 30% per trade. Perhaps the strategy is to play calls until the VIX turns higher, moving closer to 13. The best put returns were when the VIX was in the range of 12.82 to 16.09, averaging close to 30% per trade.

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The VIX's recent plunge to multi-year lows suggests a potential window of opportunity for option players, who have historically profited in similar market conditions.


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