Tuesday, July 13, 2010

A Volatility Inflection Point?

Wasn't it just last week the VIX was knocking on the door of 40? In the words of Michael Scott, "Oh how the turns have tabled." Over the past month the VIX has been like a yo-yo bouncing between overbought and oversold levels quite rapidly. Can you say mean reversion? Any chartist worth their salt could probably make the case we may be once again near an inflection point (click image to enlarge).
So how about playing a short term pop in the VIX with some short puts? With July expiration on the horizon for VIX options (next Wed.), there may be some worth selling.

Since the futures converge to the cash at expiration, we can reasonably expect the July futures to track the VIX Index relatively closely over the coming week. This is primarily why it's a bit easier to play VIX options close to expiration as they tend to be much more sensitive to day to day moves in the cash. Currently the VIX sits around 24.50 while the July futures reside at 25.85. Of the OTM July puts currently available, the 24 and 25 strike are really the only ones in play.

Suppose we took the lower credit, higher probability route and sold the July 24's for $60. Provided the VIX settles above 24 at July expiration we stand to gain $60. Though the theoretical risk with short puts is unlimited, you have to ask yourself how much lower you really think the VIX is likely to go in the next week. As for myself, I say not much.

Consider the risk graph below:

Source: [MachTrader]

For related posts, readers can check out:
VIX Settlement and Term Structure
Settlin' Them VIX Options
VIX Options
Lessons Learned from a VIX Put Matrix

1 comment:


All markets have a turning point.