Tuesday, February 17, 2009

A VIX Butterfly Play

I usually shy away from generating trade ideas, but here is a gamble that I know at least one trader is sure to be taking today: a VIX pre-expiration butterfly.

The butterfly trade highlighted below is for illustrative purposes only, but should explain the approach. The idea is simple. This butterfly trade will make a profit if the special opening quotation (SOQ) for the VIX is between 46.80 and 53.20 – about 6.4% in either direction from the current VIX level of about 50. In other words, if the VIX falls in a 12.8% band around the current price, the trade makes money.

Of course a lot can happen with the VIX in less than a day, but in terms of trading, there are about 3 ½ hours left in today’s session. Before tomorrow’s open, there are several important economic reports, including January building permits and housing starts, as well as January industrial production and capacity utilization. If those reports don’t bring the end of the world any nearer than it is now – or indicate that all the economic problems are suddenly solved – then the VIX butterfly trade should be in good shape.

Note that the maximum loss is about 56% of the potential maximum gain, which will happen if the VIX SOQ is ‘pinned’ at 50 tomorrow morning.

[source: optionsXpress]

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