VIX Call Options As Put Options

The VIX call options were closed on Friday for a 500% advance during the past three weeks (could have been an 800% advance if had caught the high price on Friday). As well, a position in the VIX put options was opened when the VIX flirted with the 30 level during the day.

I didn’t wait for the 35 to 40 range to buy the puts as planned (see previous posts: July 23rd, May 8th) because they didn’t seem to be falling much in price during the downdraft, suggesting traders were beginning to price in a VIX peak. There might be even greater VIX spikes in weeks ahead but I can average down (or cut my losses, depending on the course of events).

The particular puts purchased were the Sept 20s at a price of $1.15. In hindsight, this may have been too aggressively out of the money. Anyway, it’ll be interesting to see what they do over the next few weeks. Hopefully, investors’ fears will have subsided enough by mid-September to give them a nice gain.

It was interesting to see the market rally in the last hour of trading on Friday. The previous three Fridays, there were sharp sell-offs in the last hour. Maybe that indicates the beginning of a shift in sentiment? But of course, it wouldn’t be surprising to see a few more subprime dominoes fall – but maybe the market won’t freak out as before given central banks are stepping up to the plate and injecting liquidity into the system.

Comments

[ikkyu:]

Greetings Mr. MacDonald,

Why did you choose to buy (put) premia, when vola was high instead of selling (calls). I thought from your title you were talking about hedging with puts, but this is pure speculation. If you have a method to forcast volatilty at intervals as short as a month, i would love to hear about it. Going forward, i think people like Geoff Considine are thinking that 23-24 will become the norm.

Cheers from Tokyo,
john

2007 Aug 14 10:38 AM

[Larry MacDo...:]

John
The title is not mine. You're right: I'm not talking about hedging here. The forecast method? When the VIX shoots up quickly from a low number to 30 (near my entry point) or beyond, it doesn't usually stay there long (as far as I see from the historical pattern). The tactical error, as mentioned in the post, was buying too far out of the money. When VIX flirted with 30 on Friday, the Sept 27.5 puts might have been the better bet.

2007 Aug 14 03:58 PM

[Larry MacDo...:]

test

2007 Sep 07 07:17 AM

[athenian:]

I'd probably do the same. Many investors regard the VIX as a contrarian indicator so at higher VIX values, logic dictates buying puts that are either at or slightly out of, the money.
Peter Dunkley

2007 Aug 14 03:47 PM

[ikkyu:]

Greetings,

Thanks for the clarification. The spike in implied is saving you a bit now that we are at 4 year highs, but your are still at a Delta of (close/weds) of -.13, what some would call a roughly 13% chance of success.

I understand the principle of mean reversion in volatitlity. That gives you the direction, but not the magnitude or time frame. In a sense, isn't that likelyhood of mean reversion paid for in with your option's vega? This is why i think it is better not to buy expensive premia.

Anyhow, I think we can both agree that circumstances are most unsual.

best wishes for you success,
john

2007 Aug 16 02:53 AM

[ikkyu:]

Greetings, How are those september 20 puts treating you? Looks like they are worth about $.05. You probably closed out early or sold premia on them. Are we going to get a banner article on this trade like your VIX winner? Not trying to be a stinker, but you put yourself out there for scrutiny. I sincerely hope you managed the risk of this losing trade well. Cheers, john

2007 Sep 17 09:51 AM

[Larry MacDo...:]

ikkyu: See my Aug 20 post entitled "At Least Interest Rates Hikes Are Slowing Down" wherein the appendix has a note about selling the put options at breakeven. It was a bad trade to begin with but I was lucky enough to get out before the collapse.

2007 Sep 19 10:33 PM