Showing posts with label vertical credit spread. Show all posts
Showing posts with label vertical credit spread. Show all posts

Tuesday, March 27, 2012

Options on UVXY and SVXY Open Up New VIX ETP Trading Approaches

Whether or not I find it useful to flog the wounded horse otherwise known as the VelocityShares Daily 2x VIX Short-Term ETN (TVIX), it seems as if investors and the media insist that the wild and crazy story of this +2x VIX futures ETN remain on the front page for now.

While the TVIX story is indeed a fascinating one (see links below for more details), I fear it has crowded out a potentially more useful development from last week that has been criminally overlooked, the launch of options on two important VIX ETFs:

  • ProShares Ultra VIX Short-Term Futures ETF (UVXY)
  • ProShares Short VIX Short-Term Futures ETF (SVXY)

First off, note that the fact that these two products are exchange-traded funds instead of exchanged-traded notes means that it was much easier for options to be approved. While their more famous ETN counterparts, TVIX and XIV, grab most of the headlines, the addition of options means that traders now have much more flexibility in terms of strategy and tactics with UVXY and SVXY. 

In the past when I have mentioned how options on VIX ETPs were critical to their long-term success, I was met with a few (electronic) blank stares. Part of this reflects that fact that many have been drawn to the VIX ETPs for the potential to reap huge profits in a short period of time (more on this in The Trader Development Stage Model and the Jump from Stocks to Options) with leveraged trades. Talk to most professional options traders, however, and leverage is rarely a factor they mention as a reason for their focus on options trading. In fact, pros are more likely to cite the two key advantages of options as their flexibility and ability to structure defined risk (or limited risk) trades.

This brings me back to options on UVXY and SVXY. With UVXY down 83% for the quarter as of yesterday’s close, one would think that defined risk positions – on the long or short side – would be a critical factor in structuring future trades. With the huge contango and negative roll yield currently in the VIX futures, a directional bet in either direction entails huge risk. For shorts, this means that a short position can have its risk capped by buying UVXY calls. For longs this means that a long position can also limit risk by buying puts.

There are other ways to implement defined risk trades, notably with vertical credit spreads and vertical debit spreads, where gains and losses are limited to the distance between strikes. Traders can also just simply buy puts and calls to put a directional idea to work, knowing that their maximum loss will be limited to the purchase price.

In hard to borrow situations – which are common with some VIX ETPs – traders can also use options to create a synthetic position. For instance, a long put plus a short call is the equivalent of a synthetic short, so if no shares are available to borrow, a synthetic position might be an excellent proxy, with the same profit and loss potential as a standard short position, yet typically tying up a lot less trading capital.

Note that the markets for options in UVXY and SVXY are only one week old and not particularly liquid at this stage. On the other hand, volumes are ramping up quickly (see graphic of UVXY options volume, etc. below) and the flexibility and risk control inherent in options products makes these attractive, particularly so when applied to highly volatile products like UVXY and SVXY.

Related posts:


Disclosure(s): long XIV and SVXY, short TVIX and UVXY at time of writing; Livevol is an advertiser on VIX and More

Thursday, April 28, 2011

Reader Q and A: Straddles and Implied Volatility

Right before the close last Wednesday I placed an ATM straddle that proved to be profitable and I closed it after the IV spike on Thursday. I shouldn't have come back for more, but I placed another ATM straddle Monday before the close and even with the huge drop in price on Tuesday the IV collapse only allowed me to break even. These were my first two super short term volatility trades and now I now that the free IV data on the CBOE's website is an end of day service... definitely wouldn't have placed that trade on Monday afternoon. Seeing now that I possibly should have been doing the opposite, shorting volatility, do you suggest any strategies that aren't outright short and don't require a big amount of margin to be put up? 

Also, what service do you use to view real-time IV for ETFs and such?
Adam C.

Hi Adam,

As a newbie, you should make an important distinction between options trades that have unlimited risk and those that you should characterize as limited risk or defined risk. Shorting 10 SLV July 47 calls theoretically opens you up to unlimited risk because SLV can continue to go up and up. Should this happen, depending upon your cash cushion, eventually your broker will hit you with a margin call and you will be forced to cover at a significant loss.

Take the same basic trade and add a second leg as a hedge and your unlimited risk is now limited. Instead of a naked short, a bear call spread involving 10 short SLV July 47 calls plus 10 long SLV July 50 calls caps your loss at the distance between the two strikes. Here that is 50-47 or three points. Three points times 10 options (with a 100 multiplier) puts your maximum loss at $3000.

Make that trade right now and for 10 contracts you should receive a credit of about $1.20 for that spread, so that means your maximum profit is $1200 and maximum loss is $3000 - $1200 or $1800.

This is a directional bet. For a non-directional bet – meaning that you expect SLV to be at about 47.00 at the time of the July expiration, you should probably focus on condors and butterflies, which are essentially the limited risk version of strangles and straddles. Sometimes you will hear a trader refer to “buying the wings.” What that means is they are converting an unlimited risk strangle or straddle into a limited risk condor or butterfly by buying out-of-the-money legs to hedge their risk, just as was the case with the call spread example above. As a matter of fact, one way to think about an iron condor is that it is just a bear call spread plus a bull put spread. Early on I used a more generic label of vertical credit spread on the blog for these strategies. You should be able to follow any of these links to get more information.

An even better way to get up to speed on these strategies is with some online resources. A good place to start is with the Options Industry Council (OIC), where they have an Options Strategy Index. Click on any strategy diagram for more information. Among the many great resources out there, I can highly recommend the CBOE’s Options Institute, where you might want to start with their tutorials. Keep in mind that the options brokers also do an excellent job of educating their customers on options strategies. Two that put a great deal of effort into education are optionsXpress (Education Center) and thinkorswim (Swim Lessons).

Also, the links below should provide some specific posts that will give you some food for thought regarding your recent SLV (?) trade and some alternative approaches.

In terms of real-time IV, I use Livevol Pro, which provides the graphs that I use on the blog for implied volatility and historical volatility. Your favorite options brokers (thinkorswim, optionsXpress, TradeMONSTER, Options House, Trade King, etc.) should also have good real-time or nearly real-time IV data. If you don't have an account at a broker that specializes in options, I highly recommend you open up one with at least one of the brokers mentioned above so you can get your data and place your trades on the same platform.

Related posts:
Disclosure(s): Short SLV at time of writing; Livevol, CBOE, optionsXpress, TradeMONSTER, Options House and Trade King are advertisers on VIX and More

Friday, March 6, 2009

Markets Continue to Fall, VIX Relatively Flat

When it comes to the VIX, lately the question on everyone’s mind is why the VIX has been relatively flat – and considerable lower than it was in October and November – while the markets have been making multi-year lows.

There are a couple of ways to look at this question.

First, consider historical volatility. From a strictly statistical perspective, 20 day historical volatility in the SPX peaked at 85 at the end of October and now sits at about 41, so in terms of actual recent volatility, a VIX of about half of the October-November highs seems consistent with recent market movements.

Of course the VIX reflects implied volatility, not historical volatility and implied volatility incorporates incremental changes in uncertainty and fear on top of recent historical volatility. At least this is an easy way to conceptualize some of the component parts of the VIX. The logical conclusion is that not only is the historical volatility component of the VIX dwindling, but so too are some of the uncertainty and fear aspects.

This is not to say that the current economic environment is lacking in fear and uncertainty. Still, there is a process of habituation and coping that has taken place over the course of the past six months. Michael Kahn, writing in Barron’s on Wednesday, calls this phenomenon Slow-Motion Capitulation, which will eventually lead to an “apathy bottom.” The idea is similar to what I proposed a day earlier as a “stealth bottom.”

While I think all of the above is important, I also think it overlooks the obvious. As I write this the S&P 500 index is 57.4% below its October 2007 high. In October and November, there were concerns that the SPX could fall several hundred points more. Well it has. Now a couple hundred additional points to the down side may still be in the cards, but it will be increasingly difficult for shorts to squeeze money out of already depressed equities. Also, as investors have slowly capitulated over the course of the past year or so, there are fewer and fewer holdouts left to panic – and many of those already have purchased put protection for their remaining long positions.

The chart below shows that death by 1000 cuts will not likely trigger a VIX spike. Regardless of what your directional outlook is for equities, this looks to be a good time to be selling options, particularly using vertical credit spreads.

[source: StockCharts]

Wednesday, November 7, 2007

Brian Overby on Trading VIX Options

Steven Smith of has a video interview up in which he asks Brian Overby for his thoughts on how to trade VIX options.

Overby, who is Director of Education at TradeKing and authors an informative options blog, Options Guy, tackles some of the idiosyncrasies of the VIX and has some excellent suggestions for those who insist on trading the volatility index. Frankly, there is close to 100% overlap between what he says and what I believe about the VIX.

I recommend clicking through to the video, but in a nutshell, Overby’s thinking boils down to the following:
  1. VIX options do not follow the (cash) VIX index

  2. To understand the price action in VIX options, look at VIX futures

  3. When trading VIX options, trade the front month (closest contracts to expiration)

  4. Trade VIX options when the VIX is at the extremes of its trading range

  5. Utilize a mean reversion trading strategy

  6. Look to sell vertical spreads (sell puts when the VIX is low; sell calls when the VIX is high)

Wednesday, October 31, 2007

Selling Fear with a DryShips Bear Call Spread

About a week and a half ago Condor Options suggested an excellent mantra for those whose investing universe is populated by the likes of fear, greed, implied volatility, and the VIX: “Sell your fear to somebody else!”

It’s a simple concept, really, and one that shares much of what I try to do with the VIX. The hard part, of course, is to have the composure to calmly sell fear while others are panicking to such as a degree as to threaten to drive the price of fear even higher.

One obvious way to implement the selling fear strategy would be to do something like sell VIX calls whenever the VIX rises 15% above its 10 day simple moving average.

Consider a similar approach for individual stocks. For example, Adam at Daily Options Report posted an implied volatility chart that shows how implied volatility in DryShips (DRYS) has increased almost 50% in the past few days, as the stock hit an air pocket and fell 14% in a matter of minutes, a feat captured and analyzed nicely by Tim Knight at The Slope of Hope. Buoyed by Cramer, the continued bull market, and other more benign forces, DRYS has rallied almost 10% today, but now has some new battle scars.

It is possible that DRYS has put in a top and is now broken and vulnerable to bear attacks. Then again, this may be just another brief moment in time where the rocket ship shifts gears (see Tim Knight’s historical perspective above) before accelerating to the moon. I’m not brave enough to be long or short DRYS at the moment, but I will sell volatility at the current level. There are many ways to do this, but one way to harvest premium is with a bear call spread (aka short call spread, vertical credit spread, etc.) Thanks to the prodding I have received from several readers, I have provided an example of a bear call spread trade below from optionsXpress. Note that the trade consists of selling slightly out of the money calls and hedging/reducing risk by buying an equal amount of calls that are farther out of the money at a lower price. This trade is done for a credit, with the difference in cash in the trader’s account up front. Time decay is on the side of the trader, but the position should be actively managed, so that losses can be cut if DRYS moves sharply over 120 and threatens to go after its previous 52 week high. This is a high risk trade (a split of 120/130 or 125/130 would decrease risk significantly), but a lot less risky than a directional play on a stock with a triple digit implied volatility.

Now, did someone say something about an FOMC meeting…?

Thursday, June 7, 2007

VWSI at -6 when the VIX hits 16.35 -> short the VIX

This is my signal to go short the VIX. I'm starting with credit spreads: the June 15 / 17 calls and the June 16 / 18 calls.

Friday, February 9, 2007

Waiting for Godot

As I wait for volatility to return to the markets, I have an almost Waiting for Godot feeling about what lies ahead. At the moment, call me partly resigned and partly hopeful.

Fortunately, this is exactly where a bear call spread and call backspread can satisfy those two apparently conflicting views of volatility. You have to ask yourself two main questions before considering which strategy is the better fit for your view of the market:

· What do you think is the likelihood of a significant increase in volatility?

· If a volatility spike happens, how severe will it be?

If you are of the opinion that a volatility spike is unlikely and/or will not be severe, then you should harvest some of the implied volatility in the VIX with a bear call spread. This is a strategy that has been quite successful over the past 7 or so months, as Adam Warner at the Daily Options Report has pointed out on several occasions.

On the other hand, if you think Godot might eventually show up carrying a large volatility spike, you are willing to forego some of the premium to position yourself to cash in on that spike, then the call backspread is a better way to play the VIX. Of course, you can always buy the calls outright, but with VIX implied volatility currently at a very high level, you will have to paddle hard against the time decay current to make any progress.

For more information, optionsXpress (which generated the graphic on the left) has excellent discussions of the bear call spread and the call backspread. OptionPundit takes a deeper dive on both the bear call spread (aka vertical credit spread) and on call back spreads. These are both excellent resources for those whose options experience consists largely of buying calls and puts outright and selling covered calls – and who are open to more advanced options strategies.

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