Trading The VIX: A Dummy Making Money

by: Reel Ken

"Don't be afraid of being scared. To be afraid is a sign of common sense. Only complete idiots are not afraid of anything."
Carlos Ruiz Zafón, The Angel's Game

I have a good deal of experience in trading options and consider them my "strong suit." The vast majority of my articles revolve around these strategies.

I am less experienced when it comes to trading VIX options, as they don't behave the way normal options do. It has a lot to do with futures, contango, backwardation and similar phenomena. They can be unpredictable, and I have coined the concept of "strangeness" to describe this.

Notwithstanding my lack of experience, I wrote an article suggesting that one could sell Puts on the VIX when the VIX reached low levels (in this case 15) as a sort of "insurance policy" protecting against a rising VIX resulting from a falling S&P 500.

Now, those who follow me know I won't recommend a trade that I'm not willing to enter. So on October 10th, I sold the 15 strike Put for a credit of 34 cents. A week later, VIX settled at 14.87. This meant that I had to give back 13 cents, but still booked a 21 cent profit. With the courage of my convictions, and what I suggested in the article, I rolled the 15 strike VIX forward to December with a credit of $1.08 and "doubled down." Well, this certainly paid off, as VIX just settled at 15.57 and I earned the full premium.

A few weeks into the initial sale, happy with the results, but mindful that the VIX had risen, I switched streams and wrote an article suggesting a December/January 16 strike spread looked good.

The credit for December was 99 cents, and the debit for January was $1.01. I saw that as near perfect arbitrage, but pointed out there was some risk, but I calculated it as small.

Well, VIX just settled at 15.57 and the December 16 strike made 42 cents. In these situations, with normal options, one would expect to have lost money on the far-dated January option. This time, "strangeness" worked in my favor. I just closed out the January option for $1.20 and a 19 cent profit. Total profit on these two legs was 61 cents.

Now, that would have been nice if it was just a timing trade. But it was an insurance policy against a market drop. 'Turns out the market rose, and so did the VIX. This is counter trend, but I'll take it.

So, where do I go from here? I still see VIX trades as a form of insurance, so I will continue. I don't expect the same action to result -- that is, S&P and VIX rising -- so I'm reverting back to it solely as an insurance policy. The January 15 strike credits 55 cents and I'll double down on this.

If January finishes below 15, I'll just keep rolling forward. At some point, VIX will rise above 15 and I'll collect on the insurance. In this, I feel confident. If, somehow, that never happens, I may still make money and if I lose, well that's the cost of insurance.

But I'm also going to repeat a calendar spread, this time at a 16 strike for January/February. The January credits $1.20 and the February debits $1.25, so it looks good. If VIX falls below 15, I'll convert over to a naked put for the same reasoning as my last article.

In essence, the theory in utilizing this approach is that the lower the VIX, the greater the insurance policy. After all, you want to buy insurance when rates are low, not after your house burns down.

Summary: A "dummy" like me can trade VIX, but the trade has to be viewed as an insurance policy. Just trying to bet one way or the other is for the pros. These suggested approaches should do very well in a volatile or falling market, and may even show profit in a flat or rising market. I think the risk, though hard to calculate, is minimal.

The trades are heavily weighted in favor of a rising VIX. The strategy is premised that a falling S&P is accompanied with a rising VIX. More importantly, if it temporarily costs something, your portfolio won't complain. That's what insurance is all about -- paying off when there's a loss.

No matter what happens in the near term, markets going up and down are a way of life.

Disclosure: I trade VIX options. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.