Daily Options Report

Got this in the comments yesterday

I just came across your blog. Very impressive!

I sell OTM naked puts, and the strike prices mostly about 10-20% below equity prices. I'd appreciate it if you could share some good ways to hedge the naked puts with VIX. Buying VIX OTM calls and selling VIX OTM naked puts may be one.

R. Philbin

So I'm at the eye doctor yesterday and had the foresight (no pun intended) to remember my headphones to listen to music while I'm sitting in the waiting room with the drops in and can't read from my Iphone. And Regis and Kelly are on the TV and my big observation is that when you can watch the show without actually listening to them, it's actually tolerable. Especially the Kelly part.

Anyway, to the question at hand.

VIX Futures and Options can effectively hedge variance risk for a large portfolio. But that's really for a market making/specializing operation or derivatives trading desk. They may find themselves with overall exposure to a directional move in volatility. In fact I suspect that's the genesis of much of the VIX call buying this summer as market makers and desks were presumably shorting overpriced actual options.

But for an individual investor, be very careful with these VIX products as they don't necessarily hedge what you think. Remember an actual option is priced based on the volatility between now and when the option expires. A VIX future or option prices off a snapshot, the estimate for where the VIX will be on that one specific day.

In plain English, a November SPX put is priced on the volatility assumption for SPX BETWEEN now and November expiration. A November VIX call prices based on the estimate for 30 day volatility looking forward FROM November VIX expiration day. Even if you say you'll hedge a December SPX put with a November VIX call,  they each still carry their own independent risks. Not to mention the VIX call will cash out while the SPX put still has a month to go.