A return to normalcy occurred last week with the 18% drop in VIX and 3.26% rally in the S&P 500. Even the seasonal December pattern moderated a bit and we have a textbook contango curve for the first time since August.
On the shorter end of the VIX futures spectrum the curve flattened with a little contango with respect to the October 14th contract versus VIX. Before Weeklys in the VIX space, when volatility is low the Friday before expiration the soon to expire future would often close around a point or so above spot VIX. I expected this sort of pattern to repeat itself with the introduction of weekly VIX futures expirations. Since VIX has been elevated I don’t have enough observations to see if this will be the norm, but this week’s Friday closing prices gives me confidence that my assumption will be proven correct.
Before jumping into a trading example from last week I wanted to touch on VIX Weeklys options which came into existence this past Thursday. The first option Weeklys in the VIX space actually don’t expire until October 28th. Volume on Thursday was a respectable 4,000 contracts while on Friday things really got going and volume topped 40,000 options. The list below shows the most actively traded VIX Weeklys options from Friday.
I love digging for trades and a VIX option trade from Thursday was something I had not come across before. Work with me here, as there are several moving parts. Using the standard November contracts there was a seller of 4 VIX Nov 17 Puts at 0.80 (3.20), buyer of 6 VIX Nov 25 Calls at 1.00 (6.00), who then sold 5 VIX Nov 30 Calls at 0.57 (2.85) which comes to a credit of 0.05 per spread. The interesting payout diagram below shows the profit and loss for this trade if held to expiration.
One thought about this trade, which comes from some of the discussion I got to hear at RMC, relates to a spike before expiration. Often the goal is to take some profits on a move higher in VIX. An issue that was mentioned at RMC with respect to vertical spreads was that you would only receive a fraction of the potential maximum profits if the spread is exited on a spike. Of course time to expiration, different strikes, and other factors determine this. However, with this trade there are more long calls than short calls, could be this imbalance is an attempt to do better on a volatility spike than using a vertical spread.