VIX gained a bit (about 8%) last week as the S&P 500 was under pressure. The curve shifted in a pretty uniform manner with March adding just over 3% as contango was fairly steep on Friday the 9th. As a friendly reminder, March contracts settle on the open this coming week.
Short volatility has gotten bad rap lately due to recent price action. However, short volatility, when done in a risk controlled manner, can be a viable trading strategy all types of markets. Late Wednesday, when VIX and the April future were both around 17.25 a buyer of the standard VIX Apr 18 Puts paid 2.65 for a few hundred contracts. I know I usually get a little more exotic in this space with the trades, but sometimes it’s OK to talk about the basic strategies.
The payout above is based on holding through April settlement on the morning of the 18th. The break even for this trade is 15.35, just a bit below where VIX finished the week. However, what I want to point out is the right side of the payoff diagram, which of course is not where a put buyer wants the underlying market to go. At any level over 18.00 these options expire with no value. The point here is that the maximum loss is known, regardless of what VIX does.
VIX has historically had asymmetric price action where the moves to the upside have a lot more momentum that price drops. Of the one hundred biggest one-day price moves in VIX, only eighteen were moves to the downside. In fact, VIX has never dropped more than 30% in a single day, but has rallied more than 30% in history. The point is VIX can move fast to the upside and when short volatility, please please please, use some risk control.