Trading VIX Trading Strategies and Hedging Strategies Option

Trading VIX Trading Strategies and Hedging Strategies Option Pit

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What You Will Learn • • Quick VIX Structure Recap What Are The Characteristics Using the VIX Indexes as an indicator Trading VIX futures and future spreads Trading VIX Options directionally Trading options non-directionally Using VIX futures to hedge Using the options to hedge

VIX • • • There are many VIX indexes VIX (30 days vol index) VXV (92 days) VXMT (183 Days) VVIX (VIX of VIX) GVZ (gold) TYVIX (10 year note) OIV (Oil) VXAZN, VXIBM, VXGS, VXAPL, VXGOG

VIX • VIX options and futures are NOT options on the cash VIX that is often quoted on TV • VIX options are options on the forward value of the VIX • This means they are an option on a volatility SWAP not on the VIX itself

Trading VIX • VIX futures trade on the CFE (CBOE futures exchange) • VIX futures have a 1000. 00 multiplier and tick in. 05 • Thus each tick is 50. 00 • They trade out up to 8 months, most activity is in the front two months • Listed on almost all brokerage platforms • Less available at ‘traditional houses’

Trading VIX • VIX options trade on the CBOE exclusively • VIX futures have a 100. 00 multiplier and tick in. 05 s • Spreads trading in penny increments • Thus each tick is 5. 00 • They trade out up to 8 months, most activity is in the front two months (more even trading that the futures • Listed on all brokerage platforms

Characteristics • VIX futures and options are European exercise – This means that they cannot be exercised early • Because of the European exercise, the underlying is a forward value of the VIX • VIX forward value will correlate with VIX at about. 50 then as time passes that correlation will explode to near 100%

Characteristics • VIX expiration is wonky • It expires on 30 days prior to the next standard expiration • Always on a Wednesday 8 months a year is the Wed before standard expiration 4 months a year it is the Wednesday AFTER • Based on actual trades in SPX and can vary significantly from the quoted VIX price (google VIX settlement rigging for voodoo theories)

VIX as an Indicator • There a few things we look at using VIX • VIX vs VXV is the most important market indicator • SPX and VIX correlation Breaks is the other major indicator we look at • There are other indicators traders use, these are the two easiest to get

VIX vs VXV

VIX vs VXV • Traders have errantly thought that when VIX gets over VXV it is a sign that the VIX is topping • It usually is…but…when its not it REALLY isn't • There is a major difference between a likely to win and a positive expectancy • Buying the market when VIX crosses wins most of the time, but when the spread widens TOO much that is a sign of a market panic

VIX VXV • If one is only looking at END of day data, if one goes to cash when VIX exceeds VXV by 5 points one will pick up significant dollars relative to the SPX since 2003 just south of 200 points • If one was to be dynamic, going to cash when the two cross will provide a significant uptick in returns of a long portfolio (we will have a smarter way later)

VIX and the SPX • When the VIX is strongly negatively correlated with the S&P 500 that is a sign the market believes in the direction the market is moving • When that correlation breaks it is a sign that there is about to be a reversal in the market • Can be short term or long term but it is highly effective in the market • Helped me call the end of 2011 sell off…to the day…starting to line up now but NOT YET

SPX vs VIX

VIX and the SPX • When the SPX is down and the VIX is either flat or down as well, the market will almost certainly be up the next day and is likely to have a cyclical (relief) rally • When the SPX is up big and the VIX is not off big that CAN be a sign that the run is over, but it is less accurate than VIX on a sell off

VIX Futures • Movement is more like a carrying a chain • VIX futures do not move in unison like the S&P 500, each future is its own little individual contract, more like grains • They are correlated but not TIED together like S&P 500 or even oil and gold • Watch how they have moved the last few weeks

VIX Futures

VIX Futures • Notice how the pieces move together but not in unison • The front month is the most dangerous because it can move, although it produces the most decay • Think of the VIX futures like a whip, with the front month future being the end of the whip watch and learn

VIX Futures

VIX Futures • It can be extremely profitable to trade via day trading • Believe it or not, VX futures actually lead S&P 500 futures most of the time (smart people trade VIX) • Being constantly short VIX futures has a positive expectancy…if you are a bottomless pit of money

VIX Futures • Front month futures are extremely volatile • A normal traders like is to simply sit and be short futures • Pays great until the market tanks • When playing a stressed VIX because one thinks IV itself is too high the front month future is NOT the future to play • It makes sense to short back month futures

VIX Futures Calendars • The better trade is to be a calendar spread trader • A normal curve is in contango, one can take advantage of the exponential slide by being short futures in a calendar spread • A trader buys a 5 month future and against it, shorts a 4 month future • Covers when the future become the second month

VIX Futures Calendars . 35. 80 Off because the 5 th month is dec (seasonality)

Calendar • A straight up calendar makes. 45 in an trade • Imagine doing that trade 19 by 20 • One makes a small profit, and if the underlying explodes, one has the extra contract to clean things up • Done in a better environment (the 5 -6 spread should collect. 20 -. 25) the 19 -20 collects nicely and has little real risk: tranche trade

VIX Options • Let review the make up of VIX options volatility briefly and what makes a good directional spread…quickly

VVIX

Volatility • Unlike the VIX relative to SPX, the VIX and VVIX are typically positively correlated • When the VIX is rallying, the VVIX is typically going higher • Especially when the VIX is moving from below its mean back toward its mean • When the VIX is popping and VVIX is not, that can be a sign that smart paper is selling insurance rather than buying it

IV of VIX Options

Backward Skew • SPX Skew: puts are more expensive than calls • This is caused by collar traders buying downside protection and financing it using upside calls

VIX Skew • Since the VIX is a volatility product, customers are more concerned about the product going UP more than they are worried about it going down (more similar to WTI than SPX) • Thus, the VIX has forward skew where calls are more expensive than puts • This contributes to VVIX positive correlation

VIX forward skew • Notice that upside calls trade at much higher IV’s than near the money and bearish options • Traders usually do not use a collar in VIX options, they typically simply buy calls

Underlying Price

Using Options • Recall that VIX options ATM strike is NOT the cash VIX level but the Futures • ATM for Oct is 16. 4 • ATM for Nov is 16. 70 • ATM for December is 16. 89

Trading Long • We already know that contango presents a huge problem for those that want to trade VIX as a long • This is because of the double theta that exists in a contango environment • Traders deal with theta of the option • Traders deal with the convergence of the underlying

Trading Long • If one really wants to play long, in a contango’d environment, the only way to do so with out being crushed by curvature is through call spreads • If one is hedging, different story, but for directional traders…trade call spreads • The smarter play though is as follows

Trading Long • If one really wants to play long, in a contango’d environment, the only way to do so with out being crushed by curvature is through call spreads • If one is hedging, different story, but for directional traders…trade call spreads • The smarter play though is to follow the VIX

Trading Long • The VIX correlates to itself when it has been up, it is more likely to be up the next day • When the VIX is flat or down it is more likely to stay that way • Thus, if one thinks the VIX is going to rally, wait until it actually rallies, THEN set up the long trade • Set up long trades on a day the VIX is LOW but is UP

Trading Short • Shorting puts works too, has a big positive expectancy • I cannot stress enough how good broken wing flies and 1 by 2 s are in VIX when bearish • The other trade is the VIX-VX convergence trade • This is especially great when VIX is in contango

Trading Short • Shorting puts works too, has a big positive expectancy • I cannot stress enough how good broken wing flies and 1 by 2 s are in VIX when bearish • The other trade is the VIX-VX convergence trade • This is especially great when VIX is in contango

Bear 1 by 2 Again a floor is in VIX, this 1 by 2 has a BE of 11. 85

Bear 1 by 2

Puts VIX=12. 25

VIX is Backward • When VIX is backward it is going to stay there • The best plays are to play long (long call spread) however, the best…BEST play may be the butterfly • When a call moves from OTM to ATM even in the market blowing up as things relax and the VIX stays elevated those can be THE BEST calls to be short • BROKEN WING BUTTERFLIES!!!

VIX is Backward • • • Butterfly Trades take advantage of all the issues in VIX convergence High IV (VVIX) High Skew Time DECAY Lets review a trade

VIX FLY

Hedging • The key to hedging with futures is to wait • Every single crash has been lead by a vol spike big enough to get most hedgers into futures • The way to hedge with VIX futures is to wait until the VIX STARTS to actually go backward… THEN buy a VIX future • Typically the margin needed is about ½ of the value of a stock portfolio • Hedge when needed with futures not all the time

VIX options hedge • Looking to hedge using VIX options…. wait until VIX starts to move, preferably till the curve is flat…then buy calls • Alternatively, one can sell a super cheap OTM put at. 05 and buy a crazy OTM call for. 05 as well • That trade has a decent payout and if the market really blows up, the 60 calls can explode • That said there is a much better way to hedge consistently in a low vol environment

1 by 2 back spread • Smart pro customers use 1 by 2 back spreads • They sell 1 and buy 2 about 60 days to expiration • Trade is usually set up about 1 point above the future price • The two are set 5 -6 dollars apart • Trade costs even to. 10 a month pays out HUGE on a pop • Lets look at a bad set up then walk through an aug 2015 trade • Lets walk through the august trade

Smart Hedge 2 • Looking to hedge AFTER a major move? • Hey how about a bull 1 by 2 in the second month contract • Will be over priced • will have too much skew • Will need to be taken off in short order • DO NOT SIT ON A HEDGE THAT WORKS IN VIX

Summary • • • VIX products have unique characteristics Each has their own underlying IV and VIX are correlated Bear and bull plays have different structures Play the spikes

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