Rocky Fishman, Equity Derivatives Strategist from Deutsche Bank Securities and Andrew Warwick, Managing Director from Blackrock teamed up to discuss Hedging with VIX Option at CBOE’s Risk Management Conference in Ireland Tuesday.
They focused on evaluating VIX option strategies, not just from implementation to expiration, but also looking at the behavior of positions over a multi-week period. A comparison was made between SPX and VIX option hedging as well as looking at when it may be time to monetize a VIX hedge. They also took a look at using VIX ETPs for hedging purposes.
With respect to timing the monetization of a VIX hedge, the VIX reaction to the Brexit referendum was used as an example of how important taking profits on a VIX position can be. It was noted that in order for a VIX hedge to be effect the position needed to be exited either on Friday June 24th or Monday June 27th. After the 27th, only a position entered on the 23rd would have still proved profitable, and that profit went away the following day.
There was also a comparison between buying a VIX call option and taking a long position in a call spread. The pure long call outperforms call spreads in a severe volatility spike. Also, it was noted that out of the money call spreads need a strong quick shock to work.
Finally, three costs of having a VIX hedge were discussed. There is the negative carry that is associated with owning any option with time value. If a put is sold to fund a long call, we may be exposed to losses if there is a drop in VIX futures. Finally, if options are sold on another asset to pay for a VIX hedge there is always the possibility of experiencing losses on the short option position.