This past week was one of those where the week over week change in the VIX term structure does no justice whatsoever to the price action. The S&P 500 dropped 0.65% from Friday to Friday. However, at the worst point the S&P 500 was down 3.2% and at the highest point the S&P 500 was up 0.30% from the previous week’s closing price. In response to the rollercoaster of a week I’ve added a third curve to the graphic below. The purple and inverted line shows the term structure for the VIX futures market on the close Tuesday. Adding this third line gives traders a bit more perspective on how tough things were in the markets last week.

VIX Curves

One other point I’d like to make about the curve above is how spot VIX dropped a tad, but the futures were all higher. Keep in mind the level of VIX futures is determined by an outlook of where VIX will be in the future along with a risk premium as to the possibility of a ‘spike’ in VIX. If VIX moves lower and the futures move up it can be an indication that traders are less reluctant to be short volatility in the current market environment.

Looking over trading activity on Friday I came across a trade that is looking for VIX to stay over 17.00 between now and January settlement. Shortly after the open on Friday there was a seller of the VIX Jan 17 Puts at 0.93 who also purchased the VIX Jan 19 Calls for 0.98 and finished up the trade by selling the VIX Jan 24 Calls for 0.40. The net result of these three trades was a credit of 0.35 and a payoff that is illustrated by the diagram below –


Note where the risk is for this trade – to the downside. I included all prices down to 10.00 as that is about as low as VIX has gotten over the past 25 years, but always keep in mind theoretically VIX could go much lower. This trade turns into a loser if held to expiration and January VIX settlement comes in at any price below 16.65. Profits can run to 5.35 where any settlement over 24.00 results in payoff being capped at this level.