Playing VIX Term Structure

Over the years, I have made the argument repeatedly that I think SPX puts do a better job of hedging than VIX calls, especially in low VIX environments.  However, like all trades and hedges, that is not a rule but a generality.  There is something strange going on in VIX that is making going long call spreads in VIX very favorable.  Take a look at VIX term structure:


Currently, December futures are trading at a discount to VIX cash.  At the same time, January futures are trading at a premium.  Why?  Well, while many of you are concentrating on the fiscal cliff, I have seen the VIX do this one other time recently:  the employment report in October.  I actually think vol is getting bid up against non-farm payrolls.  There seems to be some real fear there, and it might make sense to hedge this week, even if the cliff might not be worth hedging.

Now, let's take a look at the volatility term structure: 


LivevolX (r)

December vol of VIX is trading at a nice premium to January.  Again, this points toward something more imminent than the Fiscal cliff.  While I am not certain, it could be non-farm payrolls.   So how can we play this curve?

The skew in VIX December is out of control high.  


LivevolX (r)

While the 17 calls, which are the calls that are directly out of the money, are trading for 1.00, a vol of about 90%.  The Dec 22's are trading around 128 vol.  This allows us to buy the 17/22 call spread for less than .70, an incredibly cheap trade against what could be a rocky next couple of weeks.

The Trade

We like going long VIX call spreads as hedges, I especially like the 17/22 call spread less than .70.  Take a look at the risk graph at expiration, the payout is pretty nice relative to the reward, and at the same time, the trade is long an option close to a 50 delta.


LivevolX (r)

This is the type of training you will learn in our gold course.  If you needed help following this trade, you should be in that course.  Register here, or call us (888) for more info.

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