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Individual investor from Germany, looking around the world for investment opportunities, especially where options markets are available. The US is head and shoulders regarding Options market liquidity, but there are also (options) opportunities in Europe, mainly in leading indexes and blue... More
  • VXX The Other Way Around ... A Neutral To Bullish Bet 6 comments
    Dec 17, 2012 3:14 PM | about stocks: VXX

    How do you hedge your long positions? One solution is VIX futures or options thereof. The savvy investor knows that the VIX index is a measure of implied volatility of options on the S&P 500. For more information on what exactly VIX is there are lots of Web resources to consult.

    One variation of the theme is VXX; essentially a combination of short term VIX futures, rolled regularly.

    The biggest downside of VXX is that is suffers from contango (later VIX contracts more expensive than earlier expiries). This works like a built-in price decline mechanism for VXX. And you can see it! Bring up a VXX chart of a chart provider of your choice (use time span anything between 6 month and 4 years) ... what a dog! If you've never seen it - you'll be stunned (remark: VXX has gone through reverse splits; therefore the nominally high figures in earlier years).

    VXX has often been criticized for this serial decline -- the counter argument being that "portfolio insurance" (which is what VIX and its derivatives are meant to be) costs money and if it is done right it does work well in bear markets -- as VIX is strongly negative correlated with the broad market. Though some say there are better ways to hedge a portfolio with than VXX.

    Then: Why not turn the table on VXX: GO short on VXX! But be aware that on the downturn of the broader market -- which is when VXX is supposed to shine -- it can more double! As happened in summer 2011. Of course the IV of the broader market is the all important factor as to how much VIX and VXX rises. But even a small market dip like in spring 2012 let VXX rose from $62.68 to $90.

    Remedy? There is a liquid options market of VXX -- but they are very pricey (IV >60%). Just like options in the VIX futures. Therefore, the following suggestions:

    - go short VXX

    - buy an o.t.m. bull call spread or iron condor of VXX options with expiration date in a couple months. Depending on strikes and expiry you may need more than one basket for an effective hedge. But especially iron condors can be effective while inexpensive.

    If you wish, you may try to boost your return by selling a put beneath the current going price of VXX. Your put is covered by your short VXX position. Try to get a strike that lets the option stay out of the money under normal circumstances. It may be advisable to choose expiration no further than a couple months away. VXX could well reach $24 by February barring a sharp market drop. The advantage of VXX is that it "suffers" a predictable decline but rarely a sharp drop (other than in the direct aftermath of a market correction / VXX climb). With selling the put you earn the premium.

    Be aware that being outright short a futures or ETN position theoretically carries unlimited risk, unless it is hedged.

    Be also aware that being short a put option carries a high risk as the underlying may -- in theory -- may drop sharply; theoretically to zero (although it is hard to imagine how the IV can drop to zero).

    Another way to play this is buying put calendar spreads, also o.t.m. Why not try a Jan/Feb $26 spread? As always with a calendar spread, all you risk is the money spent to open the position - in theory. Practically, you can almost always recover some of it if things don't turn out as expected (as the back option still has some value left when the front month's option expires).

    So - if VXX is really as bad as some pundits claim, let's turn the table: One trader's loss is another person's win. Let us try to be that person.


    There is one rare-occurrence but potentially big-loss tail risk: If we have 2008/9 markets all over again, VIX (the parent of VXX) could go above 100, trade in backwardation (later futures contracts cheaper than earlier ones; = the inverse of contango ==> works like a built-in price lift). Who knows how far VXX could skyrocket? The basket as described above does NOT hedge the short VXX against a monster climb.

    Therefore I will actually change the short-VXX into Leap Puts d.i.t.m:

    close short VXX futures.

    buy to open VXX JAN17 2014 PUT $40.

    That costs performance as there is an extrinsic value of about $4.20 as of today. At the current rate of decline of VXX that would take some 3 months. Also, it binds more capital as you are long the (deep in the money) put.

    Of course, any bear market would change that overall timing. But any losses are limited to the capital invested. No worries there.

    The plan is turn the condors into profit on any average market correction (no monster decline) or else wait for expiration of all the options and profit from the long put.

    If VXX rises above and beyond the condors it is time to liquidate them. Depending when (and if) this happens, the long put can be kept and the other options can be rolled over to some other strike and later expiration.

    If there is a "monstrous" rise in VXX due to (the next act of the) financial crisis, I will liquidate the VXX long put for a loss. But if that's the case there will be great opportunities to re-enter into a similar bet once the market calms down - then with even better odds for profit.

    Disclosure: I am short VXX.

    Additional disclosure: Besides being short VXX, I have (VXX-)bullish iron condor VXX options positions and a calendar spread open.

    Stocks: VXX
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  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » Here my own remarks about how this basket performs and what I am doing with it:
    Hoping for quiet holidays with an up-market. Then VXX will melt away (I am short VXX). It has started doing that. A small total plus of $20 so far although the condors (hedging agains VXX climbing) and the short-call are slightly in the red.
    The switch from VXX-short to deep i.t.m. leap put long has not occurred yet. Plan to do it around year end. If I fail to do it it can bite me....so I will do it.
    18 Dec 2012, 01:36 PM Reply Like
  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » Wed. after hours: Today VXX rose some 6 Percent or so to just less than 30.0. My basket remains quite stable. The losses of my VXX-short (calendar spread has also given up its profits) are compensated by the short put and the recovery of the condors that serve as a hedge).
    If VXX rises further we should still be OK with the condors appreciating then.
    So, generally working as planned.
    19 Dec 2012, 04:09 PM Reply Like
  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » Is this Murphy's law or what? Now that I have opened the trade, we have a spike in volatility. VXX rose almost 10% during the last 2 days combined. With the "Fiscal Cliff / Boehner Plan-B" breakdown, we could go significantly higher. I am prepared for a quick liquidation if need be. Let's see how my iron condors (which are supposed to provide some hedge) are doing. Such a sudden spike that early after opening the trade is unfavorable (of course it was clear it would come eventually, VIX and VXX were designed for a purpose).
    VIX was as around 30.60 at market close yesterday. Soon the condors could get into the money....I just checked: VXX pre-market at 31.70 i.e.; lowest condor leg now in the money. Liquidation should occur if the condors no longer have a positive delta at the latest. Otherwise the risk increases too much. I will also check whether the IV spike and the resulting spike of VIX futures reduces contango (no data yet on VIX today - not in my sources redily available here anyway). That may happen. It would also be unfavorable and thus be an argument in favor of liquidation.
    21 Dec 2012, 06:02 AM Reply Like
  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » VXX is rising. Mr. Market also wants to scare people a little. Right after market open VXX rose to 33.10, more than 7%, on top of the rise of the last days. The Condors are now partially in the money. The market is calming down a bit right now. QQQ and SPY are recovering some losses (gap down opening). VXX dropped back to 32.25. I will keep the basket open. I am somewhat in the red numbers with it but not by much. No need to rush at the moment but I'm not letting my guard down.


    It obviously looks that there is likely no deal on the fiscal cliff before New Year. The markets are open and this is its reaction: SPY down by 1.6%, QQQ by 1.67%, both actually slightly recovering (though the recovery we see at the moment could also be a bear flag. That remains to be seen). Not too good but could have been much worse, could it not? Compare it to 2008: The markets gave a big no-no when at first no deal was made. Not so today. Not at the moment at least.


    All this lets me conclude that today just looks like a normal down day so far; nothing to be too worried about. But as said before: I'll be on my guard.
    21 Dec 2012, 10:47 AM Reply Like
  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » Portfolio updates: On Dec-26, I switched from VXX-short to VXX-Put 18JAN14 $45.0, priced at $18.25. As VXX had already started it rise, I realized a loss of $213. VXX at $33.74 at time of switch. Cpt. Hindsight says: An earlier switch would've been better.


    The other (VXX-bullish) components have appreciated. With today's further rise of VXX the Condors are almost "centered in the money" (lower wing fully itm). Regarding the January expiry I therefore decided to roll to a higher base of the wing today. Replaced $31/$34 by $35/$38, also Jan expiry; realized net gain $89. This offsets some of the loss above. Also, the short put $24 is nicely in the green numbers by $63. The calendar spread is at a loss of some $26.


    Boy was I one lucky person today - and was I also rewarded for sticking to my rules resulting from due diligence: (1) If you hold short term options and a nice gain appears, do realize it! (2) If you detect a monster tail risk, eliminate / hedge it as best as possible:


    After market close Friday, the market tanked again and VXX rose to $37.55, by another $2. My rolling of the condor wing will play out nicely on Monday if these price levels hold. Also, not much too soon did I switch to leap put. That did pay off, too. I would have been in for another loss of $200 per lot; with the risk increasing in addition to that. Conversely now the leap put actually did not decrease in value at all during regular session (due to its increased implied volatility). I do expect put price decrease on Monday though if the current market levels hold. Still, this setup provides for very nice risk reduction indeed, as far as I am concerned. How to explain it? While I am generally short the market IV and its futures expiry forwarding curve, I am long what one could call the "second order IV" (the IV of the put on an IV value).


    Significant Update: I just checked: Forwarding curve changed from contango to backwardation! This puts the whole thing somewhat in jeopardy.


    Clearly, with the original (VXX-short) setup, now (next trading day) would be the time to liquidate all, and conclude that the timing of opening was just bad luck. Who am I to say exactly when the market tanks? Indeed, I would be quite wealthy already (I am not ....wealthy....now) if I could! Looking at the current situation: If however the market makes an upswing, there is a really great opportunity for a special nice gain with this setup. With the leap put behaving somewhat nicely I will use the weekend to think about all aspects of this trade. Mainly: Liquidation versus rolling up condors. It is likely that the February condor will be rolled on Monday (or on Jan 2nd) as well, unless VXX retreats quickly. Right now there is a realized loss total of $124 and an unrealized gain of $50 (market close; notwithstanding after-market movements).
    28 Dec 2012, 05:07 PM Reply Like
  • olafl
    , contributor
    Comments (126) | Send Message
    Author’s reply » Which way is up? This way! First trading day of the year, in combination with dec31, we are nicely back in business. Therefore no intention to liquidate anymore. Sharp rise of the market; sharp decline of all VIX futures by more than $4, re-establishing a contango of more than $1/month, decline of VXX to $29.
    We have turned the table (for now); principal "profit machine" (long put + calendar spread) both nicely in the greens; hedges are now decreasing today. January hedge (rolled last time) now increasingly ineffective; paper-loss of the realized gain of last trading session; rest worth only $13.
    A hedge is not a "profit center" and it did what it was intended to do (protection in case of VXX spikes). The Jan hedge has now cost me next to nothing. February hedge only with small loss. Will buy more hedge, soon.
    Total unrealized gain about $330; mainly through "principal" (long leap put gained in value).
    2 Jan 2013, 10:38 AM Reply Like
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