A Word from Our Condor

• Posted by Adam Warner
• on August 13th, 2009

Jared at Condor Options sees the same “rush to judgement” regarding an inevitable VIX rally as we do. And adds this.

Savvier traders, like member K.S., are thinking about whether to take the other side of the VIX doomsday view:

Do you have any suggestions on how to trade the contrary view that the VIX will not surge into the 30’s/40’s in the fall, such as selling VIX call spreads vs. buying put spreads?  I’m nervous about doing this due to the confusion on the part of the underlying — if I understand it correctly the options are actually on the VIX futures but the cash VIX and the VIX futures converge at the futures expiration — so on a trading basis the futures could drive different results if the futures are at a premium but at expiration they will converge.  Since thinkorswim uses the cash VIX as the underlying trying to monitor positions in VIX options has to be a little challenging.

I’m not big on the “everybody’s zigging, I’m going to zag” school of thought, but I do agree with the general concept here. I don’t think the play here is to pre-anticipate something that may or may not happen and go long volatility. I’d rather wait and see some action first and pay up if I am so inclined.

So what to do here?

Here’s Jared’s take.

As to the question about spread selection: given that the VIX complex as a whole is still drifting to new lows for the year, buying VIX put spreads might not be the best idea here unless you have an extremely bearish view on volatility – or more specifically, on future expectations of implied volatility. Selling call spreads might be a better route, but I really don’t know if it’s necessary to use VIX products to express the view K.S. is espousing. If you doubt that realized volatility in SPX will be sufficient to sustain a VIX of 30-40 later this year, expressing that view might just be a matter of putting on a short vega position for the expiration you think is most overpriced, and delta hedging that position until it matures.  Strictly speaking, it doesn’t matter what option position you choose: a simple short put or call can be just as effective as a multi-legged spread, again provided deltas are kept in line.

Yup.

There’s two different plays here. If I want to make a straight bet on options volatility going lower (or at least not going higher) I can short VIX futures, short VIX calls, short VIX call spreads, but VIX put spreads, short VXX, et. al. If I want to simply say that I’m not real sure which way this thing they call the VIX might go, but I am convinced that the VIX right now overprices realized volatiltiy, I can short something SPX or SPY options related and hedge accordingly.

And that’s the trade I like better here.

Options won’t overprice vs. realized volatility forever. Every day you own an overpriced option you lose theoretical money, be it real, or opportunity cost.  But by the same token, such a condition can exist for extended stretches. In fact much of 2003 into February 2007 saw options price in a volatility lift that indeed took close forever to materialize. It’s entirely possible we’re in a similar spot here.

Mid 20′s VIX is low if you think we’re headed to another Fall Panic. But it’s not low compared to history, in fact it’s still modestly high.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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