Friday, October 16, 2009

Pseudo Buy-Write on VIX -- Long 10 Oct calls, Short 22.5 Oct calls

A bull vertical spread with the long end deep in the money is the closest thing I have found to a covered call with VIX.   The Oct VIX options expire next Wednesday (last trading on Tuesday).   The October VIX calls have the Oct VIX futures as their underlying, rather than the "Cash" VIX which is computed off of SPX option implied volatilities.   A couple of observations:
  1. Wednesday morning, at expiration, the VIX futures and quoted VIX come together with the VRO quote that is used to settle the expiring option
  2. The VIX tends to close low on Fridays -- anticipating the time value loss over the weekend
  3. The market has been on a long bull run, a little profit taking seems in order
  4. VIX futures are at approximately 22.95,  The VIX is at  approximately 22.4
  5. Since the VIX futures are near the 22.5 strike point the premium is attractive  (implied volatility of ~75) 
I created a vertical spread with VIX 10 Oct options ( 12.70/13.20 bid/ask) as the long ITM portion, with VIX 22.5 Oct options (.90/1.05)  as the short side.  I put in a debit order at 11.95 which did not fill, and then changed to a 12.00 order which filled at 12.97 / .97.   This fill re-enforces my observation that the VIX option orders will usually fill at split the ask/bid + a few dollars in the market maker's favor.  This fill  is much better than the quoted net of (long asked) 13.20 - (short bid) .90 = 12.30.  The difference in best case profit for this 4 day maximum investment is  .5/12 (4%) vs .2/12.30 (1.6%) -- so obviously playing the spread is important.   The break even of this position is at a Oct VRO of 22.00.

I put in a limit order to close out the position at a credit of 12.40.

4 comments:

h said...

broker says Vixjx Oct 20 '09 Call expires on the 20th, could you comment what's the last possible moment to close out this call. 21st morning print? Is it possible to participate in it? or Oct 20th 4pm ET

thanks

VanceH- said...

According to the CBOE the last trading will be on the 20th at 3:15 central time, 4:15 ET , http://www.cboe.com/Products/indexopts/vixoptions_spec.aspx I have never traded VIX options after the general market close so you should check to see if there are any barriers to that in your account. The 21st will definitely not work in my understanding.

Daniel said...

Since the overall VIX trend is downward, a deep-in-the-money call exposes too much money. It is hard to be right both on direction and timing in such a short time frame. For a typical buy-write pair, one would like to hold the long side and ignore the short-term fluctuation. But the long side in the vertical spread will expire and has no chance to recover, in case the overall direction goes against you.

Have you looked at the vertical spread of +20 call and -22.5 call at that moment when you purchase your pair? The risk/reward ratio might be more favorable.

VanceH- said...

Hi Daniel, I certainly agree that being right in terms of direction and timing is difficult. Right now this trade looks to be a money loser. However, I think it is unlikely that the VIX will go below 20 in this short timeframe. I did not look at the 20 options in this case, but my expectation is that the premium on that option would have made the overall opportunity considerably smaller without significantly reducing the real risk.