market volatility

How To Trade VXX (and UVXY) Options?

When it comes to trading VXX options, it is important to understand the nature of this exchange-traded note (ETN). By design, VXX price is going to depreciate over time. Generally speaking, I mainly trade VXX options in the direction of price decay and do not buy VXX Call in anticipation of its price going up. So the discussion of this post is going to center around how to short VXX in general.

Most of what’s discussed in this post also apply to UVXY. The only difference between VXX and UVXY is that UVXY is leveraged so it moves at 1.5 times more than VXX when VIX goes up or down. I personally prefer VXX over UVXY because of the higher liquidity of VXX. Generally speaking, VXX has more open interests across different strikes and expirations.

Why I Don’t Buy VXX Call Options?

While timing when VIX is going to spike might be possible, predicting how far and how long that spike is going to last is almost impossible. It means that even though you could predict when VXX is going to go up, who knows how high up and how long it is going to last. I personally am not a big fan of buying premium, because you are fighting against time when you buy a Call option and if the predicted event doesn’t happen, you lose money.

This is why it is so much easier to just focus on shorting VXX because by design its price is going to decline over time anyway. We just need to be careful about large price spikes once in a while.

How to Short VXX with Options?

There are obviously two ways to short it, sell Naked Call options, or buy Put options. The benefit of selling Naked Call options is that you are also selling volatility so the profit will be higher. The downside is if you sell At the Mony (ATM) or In the Money (ITM) Call options, you might get assigned before expiration. It also is an unlimited risk position so if you are not careful, the margin requirement for the position can skyrocket even if you plan to hold on to the position when it goes against you.

The benefit of buying Put is that you are limiting your risk (the cost of the Put options is the maximum lost). The downside is that you are buying volatility so the profit would be lower compared to selling Naked Call options.

My Personal Preference on How to Trade VXX

I personally prefer to sell naked Calls because when VXX price spikes, this is also when VIX spikes so obviously option price would contain a lot of volatility premium and it would be more expensive buying Put options.

Over the years, I have experimented with various ways to trade VXX and even at the beginning of this year, I was experimenting with yet another way to trade VXX by combining selling Call options and buying Put options. Having tried all of these, I came to the conclusion that keeping it simple is the best. Just sell Naked Call when VIX spikes and close it early when target profit is met. If challenged, roll it out only if there is no long-term fear (see VIX to VIX3M ratio below).

Sell ATM/ITM or OTM Call Options?

When selling VXX naked Call options, some people prefer to sell ATM or ITM Call options. This is extremely risky in my opinion and I have personally got burned by doing this so many times. This is partially due to my style of trading because I do not like rushing in and out of a trade and I do not like day trading (as I stated in why I love trading the Wheel strategy post). If you have an ATM or ITM VXX naked Call, you have to be ready to get out of the position when VIX spikes, FAST!

How I Trade VXX Options

1) Keep it simple (sell Naked Call options)

I like to sell out of the money (around 0.1 Delta) Naked Call options for two main reasons.

  • It gives me more time to react when VIX spikes compared to ATM or ITM Call options.
  • Avoid getting an early assignment.

2) Watch VIX9D

VIX9D estimates the expected 9-day volatility of S&P 500 stock returns. I watch this carefully because if it spikes up above VIX, in most cases something big is affecting the stock market.

If VIX9D is above VIX, it is one of the signals for me to consider closing out my VXX short Call positions.

3) Watch VVIX

VVIX is the volatility of VIX. Essentially volatility of volatility. When it’s below 90, expect VIX to spike sometime relatively soon. VVIX has not gone down below 90 recently and at a calmer time, it frequents below 80, so the base number changes based on the market environment at the time.

This is just one of the many signals I watch so just because it is below 90, doesn’t automatically mean that I close out all of my VXX short Call positions, but I would consider scaling back at opening new positions or decreasing my existing positions.

4) Watch VIX to VIX3M ratio

VIX 3M is a measure of the 3-month implied volatility of the S&P 500. It gives a longer-term outlook of what the market is worrying about in the next few months. For example, most recently there was the US presidential election. As a result, the VIX-VIX3M ratio (Pink line) went above the average line (Green line) around October. Back in March was when COVID-19 hit the US. When a spike like that happens (red arrows), VIX will likely remain high for a while so it would be wise to get out or wait to open a VXX short Call position, until things start to calm down (green arrow).

Another factor to look for is how low the ratio is at the time. If it is close to the bottom (red boxes), most likely that trend will change at some point. This has happened recently during the summertime when COVID-19 case numbers started to go down worldwide. Even though VIX was still pretty high relative to last year’s level, the VIX-VIX3M ratio reached close to the bottom. It spiked shortly after that.

The key is that VIX always reverts back to the mean. If it goes up, it comes back down. If it goes way down, it always goes up. We just need to find the right time to jump on and off the waves.

VIX VIX3M chart

Final Thoughts

Selling VXX Naked Call is not something to be taken lightly. I know some people use the majority of their account capital to trade VXX / UVXY or other VIX-related ETN. While it works for them, this has never worked for me. I personally like to allocate only up to 10% of my total capital because when it goes against me, the margin requirements skyrocket fast. Trading VXX and UVXY was a key focus at one point for me but now that I have discovered the beauty of the Wheel Strategy, I would only trade VXX when the market condition is right.

What is your experience trading VXX, UVXY, or any other volatility-related ETN? Did you have great success with it? Please share it in the comment section. I would love to hear your story.

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