Volatility Strategies (B) – VIX Futures

This is part of a 5-part series of various execution styles for volatility strategies - full list here.

(B) VIX Futures

VIX and VIX Futures (front month), contango values in red and expressed as a percentage in blue

VIX Futures are the most direct way to express a view on VIX, but for those new to it, the danger lies in not understanding what it is and how the prices move, as it does not function like a normal stock.

For a surface understanding of what VIX Futures are, you can head here. This post is for how to go long/short the VIX using VIX Futures.

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Volatility Strategies Cheat Sheet

Volatility Strategies Cheat Sheet

Volatility strategies are categorized into 4 major views and 5 different expressions / strategies.

  1. Tactical Long Volatility: Short term trading view for when volatility / VIX is low and you expect it to increase
  2. Tactical Short Volatility: Short term trading view for when volatility / VIX is high (e.g. after a volatility spike) and you expect it to decrease
  3. Strategic Long Volatility: Permanently long volatility
  4. Strategic Short Volatility: Permanently short volatility
Links to detailed strategies:

(A) Options on S&P
(B) VIX Futures
(C) VIX Options
(D) Volatility ETFs
(E) Options on Volatility ETF


Volatility Strategies (A) – Options on S&P

This is part of a 5-part series of various execution styles for volatility strategies - full list here.

(A) Options on S&P500 index

This is an indirect way to bet on the value of VIX, but it is in fact where VIX gets its index value from. You can't however perfectly replicate VIX. Options on the S&P gives you the ability to express a view on both volatility and on equity markets.

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How SVXY works

SVXY (ProShares Short VIX Short-Term Futures ETF) is one of the more intuitive ways to make directional calls on volatility or the VIX.

For most part, it moves up when volatility is tame or decreasing, so it can be thought of as investing in market calmness. It crashes when there are market panics. If you think that sounds a lot like the stock market, you are right. SVXY is highly correlated to stocks (S&P 500 to be precise), yet somewhat different.

Skip to the end if you just wish to trade it without the boring details.

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Tactical Short on VIX

Friday was a possible decision day that turned out as not. Seems like too many were waiting on the sidelines to make a decision based on other people's decisions.

For context, we have two spikes in the VIX (two market drawdowns) just 7 days apart which is not what many are used to, given the lull in most parts of 2016-2017. Most drawdowns were quickly corrected (the one on 10 Aug a bit too quick) and the slow upward trajectory of the market resumed, so it's not usual to see a sudden drawdown occur again in quick succession. What happens after this will be telling of positioning and risk appetite.

Because of that, the below possible short trade will need to be tactical and of limited risk.

Tactical Short on VIX via Long SVXY or XIV via option spreads (vertical / diagonal) for a limited risk position

Example for SVXY: Current price 70.5, Sell 01SEP17 82 Call, Buy 08SEP17 83 Call for a debit spread of 0.35 - downside risk of $0.35 and lower breakeven at 75 and projected profit peak at 82 for $1.80 and second upper breakeven at 86 with max upside risk of $1.33

If this current drawdown mutates into a deeper correction, expect the VIX to remain elevated and the ETFs to lose even more value - this is why the position risk should be limited as this may be like trying to catch a chopper not just a knife. If the drawdown abates and things go back to 'normal', position for a gain within 2 weeks - a very rough guide.

We are at 24% drawdown on SVXY which is a reasonable first entry buy point (40% and 70% are the other possible buy points).

Regarding longer term holding periods, the chart below shows the distribution of the 250-day holding period returns is positively skewed, with only a small percentage exceeding <-50%. This should provide a baseline for expectations.