Follow Up to “A VIX Butterfly Play”

Someone asked me to explain how the VIX options trade I outlined yesterday in A VIX Butterfly Play turned out. I will try to keep the explanation short.

The original trade, which I described yesterday morning when the VIX was trading at 50.04, was as follows:

• long 10 VIX Feb 45 calls
• short 20 VIX Feb 50 calls
• long 10 VIX Feb 55 calls

To review, yesterday was the last trading day in VIX February options and today the VIX February contract exercise-settlement value was fixed at a special opening quotation (SOQ) of the VIX that was based off of the SPX March options series. Today’s SOQ (ticker VRO) was 48.40, which was 0.26 below yesterday's VIX close.

[Note that the reason the VIX has its own options expiration calendar is that VIX options settle 30 days prior to the options expiration date for SPX options in the subsequent month.]

To summarize, the profit zone for this trade was a VIX of 46.80 - 53.20, with the trade breaking even at the extremes of the range. The maximum profit was at a VIX of 50.00.

With a 10/20/10 position, the maximum potential profit for this trade was $3200; the maximum potential loss (with a VIX either at 45 or below or at 55 or above) was $1800. At 48.40, the VIX just happened to close exactly halfway between the maximum gain and the break even area. As a result, the trade gained half of the maximum potential profit, or $1600. Of course these profit and loss numbers are based on a position involving 40 calls (10/20/10). I consider that to be a 10 unit trade. With the accounting on an individual unit basis (long 1, short 2, long 1), the profit would have been $160 per unit.

In one sense, this type of trade is a pure gamble on volatility, but when volatility is unusually high, as it was last night, the profit zone can be large enough to make it a positive expectation trade, depending on one's forecast of overnight volatility.