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So much for that September sell-off that was inevitable. It never ceases to amaze me how consistently wrong the financial punditry is, and no one ever gets called out on their emphatic prognostications. (Is the ECRI out of business yet?)

I questioned the lofty volatility expectations in my last article: Fall Volatility Ahead? The Futures, Options, and ETPs Already Expensive. We did not try to predict the future market movement, we just tried to examine if volatility products were priced for something exorbitantly negative. If you bought volatility ETP put contracts after taking a hard look at the high price of the VIX futures, well, congrats to you. Long hedgies are reeling, and odds are they are underperforming the S&P 500. Let the chase begin. (That is 90% of you guys...)

See, Wall Streeters love headlines, and they even design algo bot trading programs to trade the headline in seconds. Combine this with subscription data lines to high frequency traders literally next door to the exchange, and you are decades late if you are one minute later than the Bernanke press release.

But in the case of September headlines for example, of course no one actually researches the data, or adjusts for outliers like hurricanes, wars, terrorist attacks, or dot com bubbles bursting; all of which for some reason happened in past Septembers. Furthermore, 45% of Septembers in the S&P 500 are up months. Not far from a coin flip, no? Did you hear that anywhere on CNBC? How much money would you bet on a 45/55 gamble? We are not talking about asymmetric return potential to be sure. And in the case of derivative prices in September, the odds were much worse than 50/50 due to the highly anticipated, but not duplicated sell-off and inflated futures and option prices. This is if had you chosen to go long volatility, hoping for the correction.

So where does volatility stand now? Let's take a look at the VIX futures term structure:

VX U2-CF S&P 500 VOLATILITY September2012 16:15:00 14.30 -0.70 14.95 15.10 14.25
VX V2-CF S&P 500 VOLATILITY October2012 16:15:00 16.30 -0.55 16.80 17.05 16.15
VX X2-CF S&P 500 VOLATILITY November2012 16:15:00 17.70 -0.55 18.07 18.37 17.58
VX Z2-CF S&P 500 VOLATILITY December2012 16:15:00 19.05 -0.10 19.15 19.45 18.85
VX F3-CF S&P 500 VOLATILITY January2013 16:15:00 20.95 -0.45 21.35 21.60 20.89
VX G3-CF S&P 500 VOLATILITY February2013 16:15:00 22.50 -0.40 22.75 23.01 22.34
VX H3-CF S&P 500 VOLATILITY March2013 16:15:00 23.90 -0.35 24.05 24.35 23.65
VX J3-CF S&P 500 VOLATILITY April2013 16:14:59 24.74 -0.36 24.95 25.23 24.60
VX K3-CF S&P 500 VOLATILITY May2013 16:14:59 25.33 -0.32 26.15 26.15 25.29

Alright, now we're talking. Oct's contract is below both the historic mean and median VIX, and Nov is below mean and right on the median. But should we get long volatility? Let's check the options:

10.00 VIX121017C00010000 6.30 Down 0.40 6.10 6.30 781 11,365
13.00 VIX121017C00013000 3.40 Down 0.50 3.30 3.50 1,757 2,000
14.00 VIX121017C00014000 2.71 Down 0.39 2.50 2.70 946 5,221
15.00 VIX121017C00015000 2.00 Down 0.40 1.95 2.10 2,548 7,883
16.00 VIX121017C00016000 1.63 Down 0.32 1.55 1.65 1,650 8,146
17.00 VIX121017C00017000 1.30 Down 0.30 1.25 1.35 12,447 30,395
18.00 VIX121017C00018000 1.10 Down 0.20 1.05 1.10 11,034 28,791
19.00 VIX121017C00019000 0.90 Down 0.22 0.85 0.95 555 18,436
20.00 VIX121017C00020000 0.80 Down 0.13 0.75 0.80 2,921 129,054
21.00 VIX121017C00021000 0.67 Down 0.18 0.60 0.70 1,407 47,526
22.00 VIX121017C00022000 0.57 Down 0.15 0.50 0.60 3,275 76,712
23.00 VIX121017C00023000 0.50 Down 0.10 0.45 0.55 998 67,293
24.00 VIX121017C00024000 0.45 Down 0.10 0.40 0.50 3,272 69,168
25.00 VIX121017C00025000 0.45 Down 0.05 0.35 0.40 7,252 85,769
26.00 VIX121017C00026000 0.35 Down 0.10 0.30 0.40 378 75,578
27.00 VIX121017C00027000 0.30 Down 0.10 0.30 0.35 5,735 54,755
28.00 VIX121017C00028000 0.30 Down 0.07 0.20 0.30 571 59,502
29.00 VIX121017C00029000 0.27 Down 0.08 0.20 0.30 105 21,057
30.00 VIX121017C00030000 0.25 Down 0.05 0.20 0.25 8,096 289,559

This makes far more sense on the long side than last month. With the spot VIX at 14, you can purchase the Oct $14's for $2.60. (As of the close on 9/18). Not bad as you're getting this premium at a discount to history. Any kind of VIX spike, and you could close this out with an easy 50%+ gain. The $14 Oct calls have a delta of .6, so a VIX move to 15.40 or so should get you nearly a 1.5x return. Just the structure of the volatility wave or a small spook in the marketplace could easily push the VIX over 15.

If you recall, last month we needed a move of the VIX toward 20 with the spot in the 15s for the ATM options to pay. And implied vol took a bath with Mario, then the German Court, then Angela and finally with Ben. Everyone (on financial entertainment TV) said that all of these characters were delivering lip service; but then they actually delivered.

But what if you feel that volatility is going to be absent for a while. You may believe the "Bernanke put" has sent volatility for an extended vacation? Here's an interesting idea, one that I put on myself this week. A VXX butterfly with the mid-strike being 9. Here is how this works:

This was the actual trade this week (as the VXX got pounded the last couple days, prices may be hard to replicate, but I'm sure a similar asymmetric trade will be available with the next set of weeklies) :

Buy 10 VXX Sep 21 $8.50 contracts for .76

Sell 20 VXX Sep 21 $9.00 contracts for .46

Buy 10 VXX Sep 21 $9.50 contracts for .29

This trade would have cost you .76- .93 +.29 = .12

At a max risk of $12/unit on this trade, you can make .38, a 3x payoff if VXX sits at $9. With the negative roll working against the VXX, it certainly makes you wonder why the implied vol at the money is so high on the call side. It was over 80% when this trade went on.

Source: Now That Fear Has Subsided, How To Play Volatility Using VIX Options And ETPs