Volatility Trading Digest - Strategy Selection

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Volatility Trading Digest - Strategy Selection
 
 
Strategy

Last week our suggested trade plan called for increasing the VIX hedge ratio from 10% of the portfolio to 15% on an S&P 500 Index close below 1309. Thursdays' close at 1295.11, down 24.91 on big e-mini volume fulfills that requirement, so the VIX hedge ratio should now be 15% of the portfolio value.  

At the CBOE Risk Management Conference early last week, Sogen and Peak 6 Capital Management presented a joint paper prepared in January reviewing the behavior of the VIX along with alternative short and long volatility strategies. They concluded an out-of-the- money 1x 2 call ratio spread using the second month and rolling one month prior to expiration was better than a systematic long only volatility position. Based upon their suggestion we have prepared the VIX hedge trade using Friday's closing prices.

Since the VIX March Futures expire on Wednesday, the last trading day is Tuesday. For Monday and Tuesday one month out would still be April Options, but on Wednesday one month out changes to May options. Waiting until Wednesday will save the extra trading involved in having one position open for only two days, but it means there is no hedge for Monday.

For those who may want to have the protection on Monday, we include both the April and May positions for this strategy. First for the April Future at 22.05, here is the hedge combination.

 

 

The April 27.5 calls were 1.03 each on Friday so the price above reflects the purchase of two calls. Both delta and vega also reflect the two calls for the long April 27.5 leg. There does not appear to be a volatility edge, but it is long two calls and the extra long call provides the desired extra vega that will gain from the rising implied volatility as the VIX rises. Both the cash cost and net delta are about neutral, but it has long vega shown above at .0202.

The May Future was 22.90 on Friday so here is the May position using this strategy.

 

Once again, the price, delta and vega show above represents a two-call leg for the long May 37.5 strike price.

Since the concept is to keep a continuous open position as a hedge the cash cost needs to be as close to zero as possible.

For both positions the exit or hedge unwind level is difficult to predetermine. It could be based upon a two standard deviation move, but for simplicity we are going to use a close back above the most recent high made on November 29 at 23.84 as the SU (stop/unwind).

Both of the suggestions above are based upon last Friday's closing prices using the mid price between the bid and ask. On Monday, the option prices will be somewhat different due to the time decay over the weekend and any price change.
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