How to Play a Low VIX


I thought a follow up piece on the Option Pit Volatility Report might be in order since we have been getting some noise on the low CBOE Volatility Index (VIX). The first thing to remember about options is that all the prices are relative. The low VIX is low relative to what, the impending doom of the Fiscal Cliff negotiations?

Taken against those potential moves I would say yes but that ship has sailed. The VIX is now looking at a move 30 days since that is what it measures. The only real thing on the horizon is earnings season but those are usually a volatility bust. Why do I say that? Well look at the implied volatility before earnings and after and compound the after number by all stocks that report, and it is clear the IV should recede through Earnings Season. It is actually a nice seasonal play if there is a small bid in the IV prior to the time CNBC starts cranking out the updates. Back to our question of, is the VIX low?

The chart below is the term structure of the VIX futures on January 1 and today. In the blue circle is the near-term spot price Jan VIX future. Note how it really dropped off of the map in price relative to the Feb VIX future between January 1 and January 7. The Feb VIX future is lower just not as much as the Jan. What this tells me is that the extra "premium" for volatility is not in the VIX cash or the Jan VIX Futures (which expires next Wednesday morning) but in the Feb VIX future. Right now a product that is very dependent on that Feb future is the VXX. Around 70% of its value is coming from the Feb VIX future. Note the two parallel lines that enclose the rest of the outer term structure in VIX futures. Those relative positions did not change much which I think is saying the real volatility is in March or later. That is coincidentally when the noise should start heating up over the budget again. Remember VIX did not really take off until two weeks prior to January 1, 2013. We mostly watched the market beat around in the meantime.
VIX Term Structure


The trade is one of either the short-term in term structure or long-term in the term structure. I will save the long-term for another time since those positions are not as retail friendly. The short-term is and can be played by the iPath S&P 500 VIX ST Futures ETN (VXX).

The Feb VIX future has $2.55 of premium in it to VIX cash. Considering that future will expire before the debt talks swing into action it is a little rich. Even if the VIX cash is fairly priced (which I think it is for right now, albeit a touch high) future premium will erode. That is a perfect VXX time spread using puts. If you think VIX cash will launch between now and Feb expiration this is not the trade for you.

Trades: Buy to open 3 VXX Jan/Feb 26 put spreads for $1.10, or better.

I am looking for about $0.40 on the time spread, and if things go well you can sell the VXX Feb Weeklys against the position and Jan expiration.

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At the time of publication, Mark Sebastian held positions in VIX.