On Friday I was a bit distracted by trying to keep up with what was going on in Carlsbad at the CBOE Risk Management Conference while simultaneously attending the monthly residency in Oklahoma for an academic program I’m immersed in. This morning (Saturday) I just got around to looking at the market action on Friday. I was already aware that the VIX term structure did not go into backwardation on Friday as I could see that at www.cfe.cboe.com. What surprised me is the shape of the VXST – VIX – VXV – VXMT term structure. Specifically VXST relative to VIX. At minimum, if I knew VIX was going to remain at a premium to VXST, I would have expected the spread to be narrower than 0.89.
The S&P 500 lost just over 1.5% which puts the stock market at just one mildly bad day above unchanged on the year. VIX did rise almost 14% for the week, but the long volatility funds lagged as the March and April VIX futures prices has a bit of risk already priced in to them. This could be attributed to last week being employment week or because little spikes in VIX have become more commonplace.
Late Thursday, with VXX under 27.00, there was a seller of 10,000 VXX Mar 20th 28 / 29 Put Spreads who took in a credit of 0.74. I’ve highlighted where VXX closed on Thursday and where VXX finished the week on the payoff diagram below. There’s a point to be made here.
This bull put spread trader was probably very pleased with the market reaction to the employment number as VXX moved closer to 29.00. There is still a point to go, but 29.00 is where on March 20th both options would expire with no value. At this price point trader would get to keep the $740,000 (minus commissions) credit that was taken in when the trade was initiated. So, what if they decided to exit the trade on Friday? I decided to check out the closing bid price for the 28 Put and offer price for the 29 Put from yesterday. Despite the 4% jump in VXX on Friday if this spread were closed out by selling the VXX Mar 20th 28 Put at 1.22 and buying back the VXX Mar 20th 29 Put at 2.05 the result would be a debit of 0.83 which would result in a loss on this trade. Pricing factors came into play with the 28 Put now being at the money and having the most time value relative to other strikes expiring on March 20th. The point is that the timing of a vertical spread should match up to the expiration date for the options involved in the trade. Luckily with weekly options available the flexibility to do just this exists for over 350 different markets.