VIX Volatility Trade

Currently the VIX futures term structure is in huge contango. There is also about a 4 pt premium between March VIX (22.5) and Spot VIX (18.5). On top of that, Realized Volatility of the SPY is running ~10. Everyone is quite aware of the potential of headline risk from Europe the last week and that has been pointed out as a reason for the inflated VIX levels. I think the answer is a little more complex but has a lot to do with massive inflows into TVIX/VXX ETF. The exact mechanism, I’m not sure to be honest. I do know that long VIX has been quickly gaining popularity as a hedging mechanism over long SPY puts by the large institutional clients, especially for large negative outlier risk. Barclay’s had a piece today calculating just how many futures need to be traded based on TVIX AUM:


Let me remind everyone, outlier risk is by it’s nature a very low probability event and with all eye’s focused on Europe, I am betting against such a negative outlier. Honestly, can anyone walk into work, see a headline “Greece Defaults” and actually be caught off guard? Well I guess people have done dumber stuff. In any case, I am currently short VXX via defined risk put spreads and call spreads.

However I want to point another trade idea I am considering. VIX options, which are actually priced off the VIX futures, are trading at elevated Implied Volatility levels. Getting the Implieds’ for VIX options is tough because MOST brokers do not use the proper underlying to price the option. I basically used a spreadsheet to back-solve implied volatility and I’m thinking of trading a 15/20/25 butterfly on MAR VIX as a vega trade. Vega going down will act like taking time off a butterfly. Also I’m being a little cheeky centering the strike at 20 rather then close to ATM so it has some net delta (short index vol) exposure. As of the close, it should be priced around 1.80 to pay max 5. Thoughts or comments would be appreciated.



~ by largecaptrader on February 21, 2012.

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