Tuesday, July 17, 2012

Why VIX Puts Get Cheaper in More Distant Months

Today I fielded several questions related to the valuation of VIX puts – a subject that can be a head-scratcher for even the most seasoned investors.

The put matrix graphic below, courtesy of optionsXpress, shows bid-ask quotes for VIX puts from July (which expire at tomorrow’s open) through December.

With the VIX at 16.21 at the time of this screen capture, note that for the 17s the prices for August through December have already factored in some mean reversion. For this reason, the August 17s are the most expensive on the board, with a bid-ask midpoint of 1.05. The September 17s are quoted at 0.875; the October 17s are at 0.75; and both the November and December 17s are at 0.675.

One way to interpret this put matrix is that if you were to pick any month other than the current one that the VIX is most likely to close below 17, then August is your month. Additionally, if you expect to get any money for selling VIX 17 puts, then August is the best month to target.  This is because the moneyness of the VIX options considers the full VIX term structure and with the VIX futures in steep contango, the back months are a full nine points higher than the front month (July) VIX futures.

[As an aside, things get even crazier when trying to structure calendar spreads with VIX puts. In fact, the best way to think about these trades is to consider them not to be spreads based on one underlying, but two different trades based on two different underlyings: the VIX futures for each corresponding month. This details of this subject is fodder for another post.]

Finally, for those who might consider selling VIX puts – always an interesting strategy, but often with surprisingly little premium involved – the key risk management concept to consider is that the direction of the spike in the VIX is almost always to the upside and only rarely to the downside. Short of a QE3 announcement, it is difficult to anticipate the type of news which would push the VIX under 15.00 for an extended period.

For more on the VIX put matrix, the pricing of VIX puts and some of the strategic implications, check out some of the links below.

Related posts:

[source(s): optionsXpress.com]

Disclosure(s): long VIX at time of writing; optionsXpress is an advertiser on VIX and More

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