Hell May Have Frozen Over: VIX Calls May Be a Buy

Hell May Have Frozen Over: VIX Calls May Be a Buy

One of the things that we are constantly teaching our option mentoring students is that one cannot simply look at the VIX in a vacuum.  The VIX is all about relative movement.  Today for instance, despite a move of less than 2 VIX points I think the VIX really popped.  Take a look at the move according to Livevol:

Livevol (r) www.livevol.com

While the SPX barely sold off, only losing about 8 points (and much of that in AAPL), the VIX got a nice pop of about 1.9 points.  Even adjusting for weekend (which didn’t really happen) the VIX moved up about 1.25 points a big move relative to the SPX drop.

There are a few reasons for this drop

1.  Germany, will the high court rule against what the market wants?

2.  Fed QE3 will the market get what it wants (I do not think it’s going to happen)?

3.  GoDaddy attack and AAPL tanking

All of these are good reasons for IV, which has been oversold to have rallied today.  While VIX might be done rallying (or might not) I can tell you one thing, if VIX rallies, so will the VIX future.  While Sep VIX did not backwardate, it got darn close as it is trading at only a .20 discount to the future with more than 8 days to expire.  

www.vixcentral.com

Rarely with 8 days to go, and VIX well below its long term mean do cash and futures trade this tight.  For once, the VIX futures and options might act exactly like many ignorant traders (who don't understand that it is a forward contract) would expect.  Even if VIX drops I think the VX futures might hold up better than SPX IV.  Thus:

The Trade:

For once I think it actually makes a lot of sense to go long VIX futures or VIX options as a way to hedge volatility risk or if one is bearish the market.  I think this approach will outperform a short SPX position.  With the IV and Skew steep, one might consider a call spread in VIX options as well.

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About Mark Sebastian

Mark Sebastian is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. Along with his role directing the path of education for Option Pit, Mark is currently the director of risk for a private hedge fund. He writes a daily blog, the Option Pit blog, formerly Option911. Sebastian has been published nationally on Yahoo Finance, Google finance, Financial Times Alphaville and is a featured contributor for TheStreet.com. He is also published regularly at SFO, the Options Insider, and is one of the Co-Hosts of The Option Block Podcast, a featured Podcast from Options Insider Radio. Mark is the managing editor for Expiring Monthly: The Option Traders Journal. Sebastian has a Bachelor's in Science from Villanova University. To learn more about Option Pit and their mentoring services, please visit: http://www.optionpit.com