Tuesday, December 21, 2010

VIX - Future Value, Implied Combo, Skew Comps to Past

VIX spot is quoting $16.41, unched at time of writing with IV30™ down 6.8%. The LIVEVOL™ Pro Summary is below.

The 52 wk range on VIX is [15.23, 48.20], so the 16.41 level is obviously near the low. But, the futures are pointing consistently and substantially higher, AKA "Contango."

Let's look to the Options Tab with just the ATM for all months in VIX and back out the future values (we don't need no stinkin' futures).

Using put-call parity (assuming essentially 0 interest rates), here are the future implied values of VIX as well as a nice little chart.

So, in English, although the VIX is nearing it's year low as the year ends, out to May, the future fair value is in the 25 range. Yikes... Let's dig a little deeper and look at some skew charts. Below you can see:

1. VIX skew today
2. VIX skew a year ago
3. VIX skew two years ago

Here's what I see.

1. The spot values were quite different:
2010: 16.4
2009: 20.49
2008: 44.56

2. Check out the difference in the skew shape between today and two years ago. 2008 showed essentially a flat skew. Recall that this right after the VIX had been at 80. There is more relative upside risk compared to the ATM in the VIX reflected in the options now, than there was then.

3. Look at the upside skew spread between the monthly vols between 2010, 2009 and 2008. 2010 shows the the greatest relative vol difference month-to-month. That is, each monthly IV is lower than the next by a fairly large amount compared to the other time frames (in OTM calls).

One way to look at this could be simply: "Sell that upside skew in VIX a few weeks from expo each month as it elevates."

Potential Trades to Analyze
1. One trading strategy could be to buy the depressed May OTM calls and sell the front month, one at time for each of the next 5 months. This trade leaves a covered upside and potentially ends in May with an OTM call for a credit (paid for by the other months). This strategy implicitly believes that the VIX futures curve is too steep.

2. Another take: The downside puts are way too cheap, buy them. We can see that the 15 and 16 strike puts in VIX are in the $0.05 to $0.30 range depending on month and strike. It's a small bet to own those. If VIX goes back to 10 (ish), those are a huge winner.

3. Riskier: Sell the upside naked and bet on convergence downward of VIX spot to future value. The Feb 18 calls (as one example) are priced at ~$4.10 fair value. The Feb 24 calls are priced at ~ $1.75 fair value.

4. Even riskier:
If you want to bet the VIX goes to a specific price on a specific date (or expo), sell that straddle. For example, if you think VIX is going to sit on 20 (ish) by Jan expo, sell that straddle naked @ $3.60 and be safe in ($16.40, 23.60).

5. Contrarian:
If you think we're headed for a collapse, buy a VIX call spread.

This is trade analysis, not a recommendation.

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1 comment:

  1. Thanks for the analysis! A nice breakdown of the stark, non-combined choices out there. There's a lot of room to mix and match there, and in fact, there's probably a need to do so. A few comments:

    On 1., both the steepness of the skew and its variability make the OTM Mays not good protection for the sells- more like upper-midrange disaster insurance. In a real disaster, you'd go into rather healthy backwardization real fast, as in this last summer. And with the distance to the Mays, I don't know what kind of ratio of sells you could comfortably initially deploy- I would submit that this is not the greatest candidate market for a lot of active position management, so that's important. But you can do the same thing without reaching way out there to May, be largely rid of that risk and still get the basic gains, because the curve's so steep (at the moment) until March.

    #2, buying puts, is a great strategy imo, esp in conjunction with contrary or complementary plays elsewhere, say in a portfolio where you're betting the sky is falling. This can also be played well with medium values for moderate gains, instead of just hoping for 10%, i.e., playing the Febs for 18 at the moment. Simple, safe, inexpensive. Like a stock guy's life, remember? You can almost explain what you're doing to your wife for once.

    Chaining the kind of straddles you mentioned doesn't have to be particularly risky, depending of course on your parameters- and you can use short-dated OTM calls to cheaply hedge the remaining risk.

    But outright VIX option sells, your #3? That's the kind of thing I send kids to bed without supper for. I buy from the people that do that kind of doo doo ca ca, and pray that the exchange really does back their trades when the pony starts bucking. Case in point- I note that since all's suddenly aright in the world, we're back to having these idiots fighting each other to sell me 60 calls two months out for a nickel again. This market has the potential for ridiculous discontinuities (jumps), and active hedging of that risk is impossible by having trading confined to market hours- and most of the actual jump risk is probably outside market hours. I would never, ever submit naked puts as a real-life option.

    Of course, if you want to limit your upside risk with those cheap OTM calls you mentioned, sell down the curve and hedge with options or straddles or underlyings (VIX, stocks, or I guess anything, since it's all correlated at the moment) - well, come on it, the water's, uh, fine. We can pool our pepto bizmol purchases, get the volume discount.