Thursday, September 9, 2010

The Impending VIX Expiration

It's that time again...

Each month as expiration approaches, I habitually seek out any potential short term plays using VIX options. In identifying whether or not I have a strong enough bias worth acting on, I typically consider the following data:

Recent realized volatility of the SPX via 21 or 10 day historical vol.
The posture of the VIX index - are we close to an inflection point?
A comparison of the level of the front month future set to expire (Sept. in this case) vs. the VIX index. Is there still a notable discrepancy between the two? How much?
What option strike prices are still in play and do they offer sufficient premium to construct a position?

The underlying rationale for sticking to VIX option plays close to expiration is the increased correlation between front month futures and the Index. The higher the correlation between the two, the greater my confidence level that the futures will follow my forecast on the Index. As stated numerous times in the past, this increased correlation is driven by the fact that VIX futures converge to the Index at expiration.

So what's the current landscape look like?

Both 10 and 21 day historical volatility on the S&P 500 Index reside just north of 21%'
The VIX Index is nestled pretty close to its lower bollinger band at 22.3% - tough to say whether we're at an inflection point yet, but I would lean toward being more bullish than bearish.
Sept. VIX futures are sitting at 23.8; at a 1.5 premium to the Index, futures players are still expecting a minor increase in the VIX before next Wednesday's expiration.
If I wanted to opt for selling put options, the 22.50 ($.35 by $.40) or 24 ($1.20 by $1.30) are the two closest to the money.

[Source: MachTrader]

While the 24 strike put is a little too close for comfort, the 22.50 is lacking adequate premium. I'd prefer to see a further dip in the VIX causing the 22.50 to rise in value closer to $.60 or so. At that point, shorting puts starts to attract my attention.

For related content, readers can check out:
VIX Expiration and Term Structure
Settlin' Them VIX Options
VIX Options

1 comment:

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