4 Tips for Traders when the VIX Cash Depressed

It is all over the blogosphere that the VIX futures are far exceeding the cash VIX. "So what!" the trader may ask, "How is this of any use to me?" It is pretty simple trading approach. When the VIX futures are far ahead of the VIX cash it become visible in the options via the term risk. The front month is cheap relative to the back month. On the floor I would have tried to buy gamma and sell vega. A pretty easy task all the trader has to do is sell time spreads. For the retail trader this process is a little harder. This is because most retail traders do not sit on a ton of margin. This does not mean that the trader needn’t heed the VIX-Futures spread. Here are three things retail traders can do with options when the term spread is wide.

[caption id="attachment_1933" align="alignnone" width="150" caption="Notice the ugly IV increase from April to May"][/caption]

1. Avoid Long Term-Risk Plays - This means calendars, double diagonals, you name it. If a trader insists on putting on a calendar, try overlaying a little extra back month IV, or buying some cheap front month strangles against the position.

2. Don't fear the front month - Notice I didn’t say in the above don't sell the front month. It can be okay to trade butterflies when IV is low, as long as the trader sets his or her wings using a standard deviation calculation.

What I like to do is assume I will be in the trade for 18.5 days. Then set my wing width based on the ATM strike implied volatility. This will cause my wings to be wider in high IV months and tighter in low IV months. This is a great way to mitigate risk in the instance of a break out of low IV's (Post a comment or two if you traders would like a more detailed example, this might be a great topic for the next article).

3. If the back month is still elevated over the front, then why fear the condor? - The IV term structure of options is currently very similar to what it was in January. Traders, condors did FINE in that cycle. This is because condor traders were selling the month that was relatively high.

4. As stated in number 1 don’t be afraid to spend a little bit of cash on some cheap puts - Nothing will cost so little and let the trader sleep so well. As my friend and Seven Time Broker of the Year Kevin Kennedy used to say: "Buy'em when you can, not when you have to! Because when you have to buy them, you can't!!!"

The market in general is pretty stagnant today in my opinion, reading the relative IV's the NDX and the RUT seem the most fairly priced, and the OEX seems the cheapest.

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