Volatility Trading Update

One of the bright spots of my book has been volatility trading, and more specifically, VXX and VIX options. Plenty has been written about negative roll yield and VIX con-tango so I won’t really get into details. First and foremost I try to identify the primary trend of the equity market and the relative level of implied vol to realized vol of the S&P. I discuss breadth models here. I should state flat out that I have a huge bias to shorting volatility. It just works.

In early December, market breadth improved considerably and I switched to a bullish bias. Overall implied volatility was quite high coming off the Euro Crisis and the crazy range bound trading of the summer. I begun by shorting VXX calls outright as there was a lot of juice and I had a distinct directional bet on VIX levels.

Around early January, I covered my short calls and put on a 1 x 3 VXX put spread, long slightly OTM puts, and short 3 times further OTM puts. At the time I thought there was a good possibility of an ‘aftershock’ or some quick 1-2 week correction. I could cover the short puts on any decent VXX bounce and hopefully have some free puts! That turned out to be totally incorrect and by late January I found myself long a lot of vol! Not the position I intended and took a lot of heat. I did my best to counter by selling OTM calls but the rate which VXX dropped surprised me.

By March though, there was enough of a sell-off in the market I was able to make back all the loses. At that point I was out of all the original 1 x 3 and the mess of short call options and re-established a long OTM puts in VXX. I was a little confused in mid-march about the best trade to put on, VIX had come down considerably from a level of 24 to 16 and VXX from mid 30’s to 20’s and teens. Purchasing and selling options on a lower absolute level didn’t offer as many opportunities as a higher absolute level due to fixed strike listing of options. 1 wide strike on a 15 stock is a much larger move the 1 wide on 30 stock. If fixed percentage strikes were listed, then this would be much less of an issue. Therefore, I put on way OTM put just to have a position on.

Beginning in early April I focused more on VIX options over VXX due to the strikes. I was thinking the market had a nice run but didn’t foresee any major volatility events for the next month. Though the headlines were ripe with potential land mines, the breadth model was still on a long signal. However, both realized and implied levels didn’t have much further room to the downside, so my structure of choice was selling VIX strangles slightly ratioed so I was short more puts then calls. As usual, my impatience establishing the position hurt me as VIX rallied from 16 to 20. The damage was fairly manageable and in fact gave me an opportunity to purchase 1×2 put spreads on VIX itself. By the end of April the whole position worked out nicely. I should point out that some of that garbage in the equity curve mid April was bad marks from the broker.

Coming into May the breath model is still long and even though last Friday was brutal, I’m trying to stick with my position. I’ve rolled the Strangle to June options and still short more puts, I began adding long MAY calls to hedge in case the market really begins to turn bearish. I must admit, if the market mantra of “sell in may and go away” plays out again this year, I would be quite surprised and would be even more surprised if it was due to issues from Europe. It’s my assumption that the market is aware and has discounted these problems but I am cognizant that central bank interventions could distort this market. But at any rate, until the breadth model flashes sell, I’m a bull.

~ by largecaptrader on May 6, 2012.