Good Time to Buy VIX Call Options

We’ve seen the S&P 500 go up in a strong linear fashion since mid July. A bit extended perhaps? Here’s the 3 month chart:

We’ve seen some fairly low values in VIX over the past few months as Here’s the 2 month chart for the VIX:

Incredible to see a few days under $11. It’s been down at $11 before (even as low as $10) as seen in this 3-year chart:

What’s interesting is the behavior of the S&P 500 relative to the VIX. Here is a chart showing the two:

An obvious pattern shown clearly in the chart above is that the S&P 500 is climbing well when VIX is falling. This is usually over a 2-3 month period:

· May-June 2004

· mid August-early October 2004

· late October-Christmas 2004

· mid April-late July 2005

· mid October-Christmas 2005

· July-current 2006

If the current trend (upward S&P 500 and downward VIX) continues, then this would be a significantly larger and longer decline period of the VIX (going into 4 months). We’re currently just past the 3 month mark.

Looking at the 3rd chart above, $10 seems to be a fairly firm floor, although it seems like VIX doesn’t like staying down there. There’s almost a propensity for the VIX to bounce off $10-$11 and within a month reach $14-$15.

Bottom line: This looks like a good time to buy VIX call options. If the S&P futures look weak Wednesday morning, a quick entry may be in order … I started off this piece with the question if this rally may be a bit extended. Patient watchers may want to “wait and see” in the hopes of entering when VIX is closer to $11.

Comment on this article

Comments

[WC Whiner:]

I have bought VIX calls (and made money, almost entirely due to luck), but if you think vols are low -- buy vols. VIX options are really VBI options -- not so much options on the current vols as on the closing vols at expiration. The latter are less volatile themselves, and the options are Very Expensive Indeed.

Buying a boatload of el-cheapo calls and puts on some indexes seems the best bet.

It's what I've been doing.

FD: I am often wrong.

2006 Oct 18 02:45 AM

[Richard Kang1:]

WCW: I'll be perfectly honest. Like you and basically everyone else out there, trading VIX options for me is a work in progress. It isn't actually that surprising how different VIX and its options behave. I know quite a few hedge funds that are trading this market (both options and futures) with incredibly mixed success. Those that are doing fairly well are staying relatively quiet as they are unsure how long they can keep up the good returns. Most admit that VIX trading is not a continuous program but one that is usually "off" and swithches "on" very few times of the year.

As a big ETF user, I hear you about costs. Your "el-cheapo" strategy is clearly the more Excedrin free approach. I only wonder how the VIX derivatives market will evolve in time as more participants enter. It's been getting more press over the year since options trading commenced.

For me, as a portfolio manager, I simply like the concept of VIX as an ultimate (maybe even the ultimate) diversifcation tool. In a world of increasing correlations (I've discussed in this site how the emerging markets ETF is highly correlated to the Canadian ETF), it's harder to find the right tools to offset market drawdowns. Index puts and the new inverse ETFs (along with basic shorting) are fine but VIX provides another area of research for me.

2006 Oct 18 09:46 AM

[dealingpcm:]

How can I go about learning about trading VIX Options? Where can I open an a/c to trade them? Thanks

2007 May 30 11:55 AM

[Richard Kang1:]

Info on trading VIX options and futures can be found here: www.cboe.com/micro/vix...

If you run a google search, you'll likely find many more sites/blogs that cover VIX. Any brokerage firm, online discount or otherwise should be able to help you out with margin accounts to trade options.

2007 Jun 01 01:04 PM