It has been a while since my last blog post. If you have been actively following the market, as you know, it hasn’t been easy for many of us in the last several months.
I was focusing on trading the Wheel strategy for the last couple of years and came to the realization that it’s not about what trading strategy to use. It’s about the ability to read the market after all.
Let me explain.
It’s all about reading and understanding the Market! Stupid Me!
If you have checked my previous blog posts, you probably start to see a pattern. I would get into a particular trading style or strategy, thinking it would be THE SOLUTION to rich.
First, it was the Tasty Trade Method focusing on probability. The problem with relying 100% on probability is that the calculation is based on a fixed window of time (in most cases it would be the trailing 52 weeks of data). The probability could change dramatically depending on the market condition.
In other words, the 70% winning rate that the trading platform is telling you doesn’t mean much. It’s a calculated prediction with a fixed time window of the historical data.
The reason that the Wheel Strategy was working for a while was that it was an uptrend market. In fact, I might have made more if I had just bought call options. Nonetheless, it did work and I did make some profit. However, it stopped working pretty fast when the music stopped and the market started going south.
The reason that I failed again was not that I chose the wrong strategy. It was that I did not know how to read the market.
Why Trade VIX Options?
Along with the Wheel Strategy, I was also trading VXX but then Barkley suspended the issuance of new shares in March 2022. This effectively eliminated the contango effect and caused the VXX price to stop reflecting its indicative value. In other words, its price could go up and down based on demand like a stock and it stopped tracking and reflecting on what’s going on with VIX, which is supposed to be its primary purpose.
This had led me down the road of finding ways to trade VIX options, which I had tried previously without much success. The primary reason for that is its complexity. VIX options are based on VIX futures and not the VIX Index spot price.
For example, VIX options for July expiration are based on July future, which is 27.37 and not the 24.79 of the VIX Index spot value (image below).
In other words, if you buy a call option for July future, the only way for you to make money is for the July future to increase.
Let me give you another example, let’s say you bought a Jun expiration VIX call option on April 11, 2022. The June future value was 26.62. (1st image below)
Then on April 28th, you saw it jumped up to $29.28. So it was about 3 points jump. (2nd image below)
However, when we look at the VIX spot price, it jumped from 23 to almost 30, which was an almost 7 points jump. (The table below)
Obviously, the VIX June Call option price is based on the June future so the profit is not as high.
I have tried so many times before with buying or selling VIX Call spread or Put spread but have never been able to make a profit as large as trading VXX when the same amount of move happened with the VIX index.
So what changed?
Reading Market and Understanding the Nature of VIX
First, I started learning more about how to read the market. Since VIX is based on S&P 500 options activity, reading the movements of SPX helps predict what would happen with VIX next.
I also learned more about VVIX, which is the volatility of VIX. VIX options are largely affected by volatility just like stock options. When VVIX spikes, there is more premium on the VIX options.
Additionally, I started tracking the Percentile Rank (PR) of various VIX-related indicators such as VIX9D, VIX3M, VIX6M, and of course VVIX in relation to VIX.
These values can act as early warning signs and also confirmation.
Omicron News as an Example
Let’s use the Omicron news that broke out back in November 2021 as an example.
- The news came out on the night of Thanksgiving day (November 25th) and the market tanked the day after (November 26th).
- Looking at the PR of VIX3M, it was already spiking a few days earlier since November 22nd. (Red box in the 1st image below)
- The market would recover but started to go down again on December 16, ultimately reaching the bottom on December 20th. (2nd image below)
- While SPX was going down starting on December 16th, only the PR of VIX9D increased significantly. The other three, especially VVIX did not move much even though it was a large drop in SPX on December 20th.
As you can see, using these PR values could be very useful in understanding what the market is thinking. The market, after all, is consist of people.
So, What is the VIX Options Trading Plan?
Now that we have a better sense of what is happening and what might happen using all these tools, we could better position ourselves with VIX options.
The foundation of the options trading strategy doesn’t change. When volatility is low, options are cheap so buy them. When volatility is high, options are expensive so sell them. In case this concept confuses you, check this post to learn more about options strategies for high and low volatility environments.
Below is a table for the current PR of the VIX products that I track (the table below).
One thing that really stands out is the PR of VVIX in relation to VIX is really high at 99%, despite the fact that VVIX has actually dropped to below 90 (2nd image below). It seems the market is bullish in the short term, but something might be brewing or people are expecting something might happen soon.
This also makes sense considering SPX hasn’t broken the Trendline, people are still not sure which way the market would go (3rd image below).
VIX Call Calendar Spread
Since VVIX is getting lower, it’s relatively cheap to buy VIX options now.
One contract of 30 Call Jun/July Calendar Spread can be bought for $1,234 with a standard margin account. The max profit is around $200 (15% return) if VIX ends right in the middle of 30 by expiration.
The downside damage is pretty small if managed well, especially with the current market condition and the nature of VIX that it always reverts back to the mean. It is highly probable that it will end up between 26 and 36 in the next 2 weeks.
Thinkorsiwm shows the probability of losing on the expiration date at about 50% (2nd image below), which as I explained earlier, I don’t really care about this number anymore.
Obviously, how to manage this trade will largely depend on how S&P 500 moves, but on paper, this seems to be a good trade setup.
What do you think? Do you have other ideas on how to trade VIX options?