We know volatility in the overall market, measured by the VIX, closed Friday, August 24, at $15.18 after falling 4.89% over the course of the day. Traders and market participants wonder where to look for volatility in search of trading ideas, expected movement, and expected risk in assets. As earnings season slows to a halt, traders will be diligently searching for opportunity to sell premium. With less spikes in many liquid underlying assets around earnings announcements, traders need to be creative. Blindly staring at the Volatility Index, VIX, and waiting for the index to rise so we can sell premium in the S&P 500, will not work, but if we look deeper into the index we discover hidden volatility right in front of our eyes.
Volatility in the VIX is quite high. Looking at the front month VIX options, we see an expected move of 3.2 over the next 23 days leading to September expiration. September options are currently trading with a 100+% volatility. October and November options trade with 80+% volatility as well, indicating wide expected moves in the index over the coming months. Can we determine which way the VIX move is expected?
Trading at currently $15.18, the VIX options indicate an upward move. VIX SEP puts, strike price $15 trade at $.15bid, while out-of-the-money puts are worthless. Similar pricing is seen in October and November option contracts. Looking to the call side of the option chain we can see the in-the-money call options all have a break-even point $3+ above current trading levels. Remember, $3.2 is the expected move for September. Based on option pricing models and historical patterns, we can have certainty in believing the VIX will trade higher in the coming months. Now, how do we trade a position to take advantage of this high volatility and our directional outlook?
The following is not a trade recommendation. It is an illustration of a strategy based on expected move and price volatility:
- Long Call Butterfly
- Price target $18 at September expiration.
- Buy 1 SEP Call 17, Sell 2 SEP Call 18, Buy 1 Call 19. Mid-price=.1 debit
- Break Even VIX Prices= 17.1/18.9
- Max Loss $1
- Max Profit $9
- Buying Power Used: Minimal
Disclosure: The author currently holds long and short VIX options positions. 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.