The main premise of the following article is to provide an update on the VXX trade as well as a few other ideas.
On August 22nd, 2011 I wrote that it was time to start looking at shorting the VXX via OTM option trades. Specifically the trades I wrote about are as follows:
- September $46-51 1:2 call ratio trade for a $1.35 net credit
- Short January $65 calls for a net credit of $5.00
The current outcomes of the trade have only been resolved for the 1:2 call ratio trade; which expired worthless thus the trader collected the full $1.35 net credit. The short January $65 calls are still OTM and carry a market price of 4.78 (last trade but the bid/ask spread was $4.45 / $5.15, respectively).
So overall, someone following my trade would be in the profits by $1.35 and likely a bit more if they closed out the January $65 calls.
When I wrote the article the S&P 500 was at $1,123 and VXX was at $43.86. As of Friday October 7th, 2011 the S&P was at $1,155 and the VXX was at $50.22 (market price not NAV).
The markets have been up and down since as well as the volatility index and also VXX. VXX has benefit from being in backwardation and that still may linger. However, since VXX owns and rolls VIX futures and the VIX is a product essentially made to revert to the mean (and have contango rolls) I still think VXX is something to be played from the short side.
If your bearish on the markets or think volatility is going to rage like never seen before then I implore you to pursue SPY options. Or individual stock options as both of those products do not have contango rolls to deal with over the mid-term. Though we may have a month or two more of backwardation rolls for VXX.
The broad market set up a nice chance for a bullish rally to continue on into next week and possibly through year end based on staying above support this week and possible resolutions coming out of Europe. I am skeptical of this however and would prefer to be bullish via solid individual companies. Some of these I have written about in past articles and are a part of my current holdings. Others are not yet mentioned but will during the fourth quarter. All of these will be “long-term” core holdings and should have a strong & healthy dividend repayment ability with a yield above 3%.
Why if I am concerned about the broad market, economy and continued de-leveraging would I still recommend being short VXX. Because VXX over the long run (and I am playing this from a very long term perspective just like I have done with UNG for years) is a “massive and epic” product to be played bearishly. However, as this recent run up has proven and some backwardation rolls that prudence and timing is still critical to avoid heavy short-term losses. That is why I like the strategy I initially deployed back in August and am profitable even though VXX is up by more than $7 a share since the article.
Trade recommendations on VXX at this time could be a continuation of the August article or could be looked at as a stand alone trade. If the readers are viewing this as a continuation of the August article then they have $1.35 in profits and half of their “risk” back available for future trades. The January $65 call position is at a slight profit and might as well be closed out at this slight profit.
The reasoning on the January $65 call position to be closed is part of the backwardation rolls that could occur but the ability to “trade” prudently. Close them out at a slight profit (as of Friday closed) and roll the naked calls to the $75 calls on the March 2012 expiration. The $75 calls could have been sold on Friday above $5 per contract. So essentially by rolling the position for three more months you gain additional cash (selling the $75’s should net you $5+ while the $65 traded at $4.78) while being $10 higher on the strike price if assigned.
To me that remains a no-brainer type of trade due to VXX flaws over the long-term and the VIX essentially being a reversion to the mean trade in normal times. For those doomsayers, please study the VIX product and VIX futures and you will find out that even if you are right about outright market destruction that you would be more profitable in other areas than being long VXX or the VIX futures.
The second and third components of the trade are pretty simple.
Another 1:2 call ratio trade involving the December $55-60 calls for a net credit of $2.30. If assigned short (VXX above $60 in December) then one would be short the VXX @ 67.30.
The third component of the trade is to buy put options long or put spreads for those not wanting to pay the net debit. I like March 2013 expiration put options in the $35-40 strike range and the December expiration $45-$50 puts.
As stated before the positions on the short / naked call side need to be sized small (in terms of your portfolio position) so you can withstand assignment and further price rises against your position. You do not want to make a mistake in this area as you could be bounced out of your position at a substantial loss prior to the VXX pulling back and starting its massive decline.
I will also say this and it is really going out into the future. VXX will again have a reverse split as the decline of the VIX and VIX futures back into the 20’s with contango rolls will absolutely destroy the share value in VXX.