Sunday, March 20, 2011

VXX post-mortem

This is one of those trades that happened so fast I never did any pre or post-analysis until now. I wasn't sitting around waiting or even anticipating that VIX would spike up. I just happened to be watching on Wednesday when the panic hit. I was already in a position with short 48 strike calls on VXX for APR expiration that I sold for .46. At the time that trade was put on VIX was at 25 and VXX was 35, so this was meant to be an income play but I'd be more than willing to stay short volatility if I inherited a short position up there. Now, because I already happened to be short those calls, when the spike in vol happened I noticed my marked-to-market position on VXX was way upside down, like by more than $-2,000 on just 10 contracts. I thought this couldn't be right since VXX was at 38, I was still $10 OTM!! So I bring up the option chain to confirm what is going on and see what looks like free money.

The IV of VXX had shot up over 100% and the skew was crazy. The IV was going up higher and higher for the farther out strike prices. Normally I'm a proponent of assuming that options are efficiently priced, but take a look at the screen shot I made of theoretical price versus the price trades were going through at. I thought this was insane so I decided to double up on my short position of another 10 call contracts, pucker up and hope the world doesn't go truly insane. I was definitely nervous of what was on the news and why VIX was spiking so hard, but at this price I would be at a cost average of over 50 on VXX, the 49 calls were the farthest available strike price offered for trading, I'll take that risk. I was not assuming or even guessing that the VIX wouldn't or couldn't go higher. I just felt like I was panicking a bit and I wasn't even long stock, so I've been around a while and felt that feeling enough times that I felt comfortable that the logical play was to try and sell some fear, even though I admit I was feeling some myself. T

It turns out I got lucky and things didn't get worse. I was able to close this trade out for 72% of the max profit in just two days. I felt like taking the gains and leaving myself the margin availability to jump on a similar trade again in the next week if it appears. This post isn't to say look at me I make a quick kill, it's to show you what I was seeing in case you come across it yourself. The options market was not pricing in risk efficiently and as a trader that is something we should be taking advantage of. As long as you're not using a position size that can hurt you, your risk here is that VIX goes above 40, VXX above 50, and never comes back down. That's not a logical assumption.

I didn't pull the trigger until I had reason to believe we peaked.

Take a look at the increasing IV of the calls

Theoretical price vs trade price. The purple line is Theoretical Value, the white and red boxes are the prices trades are going through at for the 49 strike calls. The green boxes are my entry and exit points. Notice that I received far more than theo price for selling but only paid a few pennies more than theo price to buy back. This concept in isolation is an example of a good trade, the fact that I got lucky with timing is not what makes the trade good.


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  1. Nice trading. I need to study options on VIX, it is something I haven't looked at, but from things I have heard on different webinars I understand that they are a little tricky for the average retail investor. Like futures, this is another instrument I want to add to my arsenal in order to be able to take advantage of market conditions when the opportunity arises. How long have you been trading VIX options and have you found them to be a fairly straightforward instrument to trade?

  2. I have not traded VIX options yet, I'm in the same boat as you on that, need to learn more about them. The first time I took a look at them it wasn't so straightforward so I put it off for another time. I traded options on the VXX which is a VIX ETN that has options. It isn't a great proxy, it has it's flaws. But they work exactly like equity options so I use it because I understand the risk/reward and there are no settlement complexities like VIX options seem to have.

  3. So you were naked short those calls, what was the margin on that?

  4. There is some important info on VIX options at this link.

    From what I have read, point 5 is one of the main points that the average retail investor fails to appreciate. I'm not familiar with VXX, I'll look in to that next. I think what many of us are looking for is a simple instrument to use just to make a bet on where we think future volatility will be relative to current volatility. If I figure out what that is I'll post it.

  5. Brad: I'm still short 10 of the 48 strike calls from my first trade and currently it's showing margin of $3,865

  6. Sorry to change the topic but I am not aware of a better place to start this discussion where it will be seen (if there is let me know).

    Like many others I started in options by selling covered calls, and still have a lot of stocks in which I do that. I have never really analyzed it myself, but I've read that the Monday following options expiration is one of the worst times to initiate new covered call positions because the herd is all doing it at the same time, big supply, market makers take IV way down,etc...
    Right now I have a bunch of short calls that expired on Friday, and I will be waiting for later this week or maybe next before I write them again.
    So that gets me to wondering, if this phenomenon is real can we use it to our advantage? So on Monday if calls are cheap, maybe it is a good time to be a net buyer of options, such as buying an OTM call calendar, or call debit spreads. Obviously you would only do this if you liked the trade on it's own merit, but all things being equal and if that were the case, I wonder if there is an advantage to doing it on post-expiration Monday? Right now I own an OTM call calendar on QCOM (April/May 55), mid-price $1.05 as I write. I paid $1.04 for it but initiated this position on 3/11 and it has been a loser until today. Since I own it I watch it anyway, but if the underlying price were to stay the same it may be interesting to see if the price of the calendar changes much over the next few days.

  7. Just for the record, at the moment the IV's for QCOM calls are as follows:
    April 55- 28.96
    May 55 - 31.44

  8. I have not seen any empirical evidence of this, but I have heard the guys on the Friday chat at Think or Swim mention something similar. They always advise rolling out within the last few days of the month. My background until a few years ago was strictly a covered call writer so I'm familiar with your story.

    I never closed out early and always looked forward to the first Monday after expiration so I could sell more calls. Back then I didn't understand IV so wouldn't have been able to know if there was an inherent disadvantage to selling on that Monday. I guess you can do your own VIX study and see if the net movement on the first Monday is statistically significant compared to any other day.