Tuesday, June 15, 2010

Exiting the Volatility Fray

Last week's Entering the Volatility Fray marked my first stab at playing VXX options. After experimenting with a few different strategies, I settled on call ratio spreads. Three key factors went into my decision. First, VXX options had some pretty steep upside skew making the OTM calls relatively expensive. Second, volatility had reached lofty enough levels to make me a seller. Third, call ratio spreads give me quite a bit of leeway due to the large profit zone.

I ended up exiting the trade yesterday once I had captured the majority of the original credit received. I originally sold the spread for $140 credit and exited yesterday at $20. With a scant $20 left and about five weeks remaining until expiration, it was a no brainer exit. Since the SPX held the 1050 level and staged a nice little rally, we've seen fear dissipate out of the markets a bit. Not surprisingly, VXX stock has come in and has seen an easing in demand for its out-of-the money calls. Take a look at the following two skew charts displaying the vol levels of the July 40 strike calls at trade inception as well as when I exited.

[Source: Livevol Pro]
I originally sold the 40 calls when they traded at an implied vol of 108%. The 7 point drop to 101% coupled with the notable drop in VXX stock quickly depressed the calls involved in the trade providing me with a swift exit.

For related posts, readers can check out:
Volatility Skew and Ratio Spreads
Gaming the Gold Bugs


MarkWolfinger said...

If you entered a ratio spread, then there was a whole lot more than $20 potential profit remaining. [Plus lots of risk]

I am not saying exiting was wrong - all I am saying is that there was more than a 'scant $20 left'


Tyler Craig said...

Hey Mark,

I probably should have been more clear on that. I was referring to having $20 remaining of the original credit received. Originally we entered the Jul 37-40 1x2 ratio spread for $1.40 credit. The max profit IF VXX remained below $37 at expiration is $140. So, of the potential $140 the trade had achieved $120. The profit zone certainly does open up as we approach $40, so yeah the max profit is technically higher than $140. But we have to get a HUGE move in VXX plus have a good 10-20 days of time decay go by to have the profit increase.

Though VXX may head back towards $37 to $40, I'm basically satisfied with the accumulated gain and don't think the remaining risk/reward ratio is worth it. I'd rather exit now and enter another trade at better prices if we get another surge in volatility.


Nice charts great graphs.