Tuesday, April 14, 2009

VIX Expiration Straddles

With less than an hour left before today’s trading session comes to a close and the April VIX options can no longer be traded, this seems like as good a time as any to mention a pure overnight volatility gamble: the VIX expiration straddle.

I have difficulty calling this trade anything other than a speculative gamble and am certainly not recommending it, but there are some who love this type of trade.

As outlined in the optionsXpress graphic below, the VIX is at 37.61 as I type this, just 0.11 above the 37.50 strike. In the example indicated in the graphic, selling 10 April VIX 37.50 calls and 10 April VIX 37.50 puts nets $1250. If the VIX settles at tomorrow’s opening at 37.50, this is the maximum gain. As the profit and loss table shows, break even is at 36.25 and 38.75. A loss comparable to the maximum profit of $1250 will be realized at 35.00 and 40.00. If the VIX settles below 35.00 or above 40.00, then the losses will be even more significant. For long positions, the numbers are reversed.

That is pretty much the trade in a nutshell.

Anyone making this trade should be aware that there are several important economic releases before the open tomorrow, including the March CPI data, March industrial production and capacity utilization, and several others. In addition, there is a fairly large slate of earnings due out after the close today and before the open tomorrow. In short, a lot can happen overnight.

Still…if you think the VIX will settle between 36.25 and 38.75, a VIX short straddle is one way to put that idea into action.

It is also important to keep in mind that most options players who are looking to make this trade will likely be doing so several weeks before expiration and close the position out prior to the last trading day...but there are others like like the overnight approach.

For two related VIX expiration options plays, check out:

[source: optionsXpress]


Anonymous said...

What's your take on the CSFB Index as discussed in the most recent Barron's?


Bill Luby said...

Hi Jon,

I like the index and think the collar valuation approach has some merit. I was going to post about it today, but got tied up in other things. Look for some more detailed thinking on the subject tomorrow.

Readers, I'd love to hear your opinions about the Credit Suisse Fear Barometer too.



Anonymous said...

There isn't any fear in the market -- just opportunities to make money. They load up on puts because it can make them a ton of money, not because they fear anything. That's why this whole CSFB thing is just a marketing trick and nothing more.

Bill Luby said...

FWIW, VIX April options settled at 38.20, so the example trade above made .55/1.25 of the maximum profit. Using the numbers in the example, the sale of 10 puts and calls translates into a profit of $550.

Perhaps a more important point that I failed to repeat in the post above is that losses to the straddle are technically unlimited, whereas the condor and butterfly trades referenced at the bottom are 'defined risk' trades, meaning that the maximum possible loss is defined when the trade is initiated.

On the other hand, to determine the potential loss if the VIX were to spike overnight, just subtract 38.25 from the potential VIX close and multiply by $1000. So...a VIX of 48.25 yields a $10,000 loss, a VIX of 88.25 triggers a $50,000 loss, etc.

This is why traders who trade condors and butterflies sleep better at night...



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