Did the VIX Overreact?
Did the VIX Overreact?
Much of the financial world was waiting for the results of Spain’s stress test on its banking sector. And the big surprise was not how much they needed ($69 billion) but that it was not more. That news in and of itself perked the market up in the morning to trade close to unchanged after the rally yesterday. Then for whatever reason the stocks sold off slowly pretty much until the close.
As usual with an Option Pit blog I am more concerned about how the volatility reacted with the selloff. The morning was pretty much normal given the quick drop. I expect the VIX to rally around 7% or so with every 1% move down in the SPX. We pretty much got that. But looking below we got a pretty good rally in the VIX at the end of the day even when the market did not hit new lows. It really felt like the weekend got jammed back into the options as a last resort. Call it window dressing for the juice.
The pattern after all of the Euro news this year is that volatility usually subsides (it did quite hard yesterday after some tough talk from EU governments) once the smoke clears. I don’t think today should be any different. This feels more like an end of the quarter anomaly.
The Trade
The weekend effect should be pretty flat on Monday with the mark up today. The best way to fade this volatility pop would be to buy put spreads on Monday in the VXX nearest term (think 8.5/9) and blow them out after the VXX hits 8.5 by mid-week.
Full disclosure: I have VXX positions.
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