Block Trade Analysis – VIX Bull Call and Iron Condor Spreads

We had two big trades come through the VIX pit on Thursday and about the only thing they have in common is that they both used March VIX options.

First, there was an out of the money bull call spread.  With spot VIX around 22.60 there was a buyer of 80,000 VIX Mar 27 Calls at 1.95 who then sold 80,000 VIX Mar 35 Calls at 0.91 for a net cost of 1.04.  A spike to just over 28.00 gets this trade to the point of profitability.  This requires a closing high for 2016 in VIX since that current number for 2016 is 27.59.  If the trader is nimble, they may find a good exit opportunity if the intraday high for VIX in 2016 (32.09) is tested between now and March settlement.  Needless to say for this trade to pay off the equity market will need to take a dive from current levels and do it in a dramatic fashion.

VIX PO 1

 

 

What makes a market is people with different opinions and the second big trade from today has a different opinion from the first.  With VIX at 23.68 a trader constructed an iron condor using March VIX options.  They sold the VIX Mar 20 Puts at 1.40 and sold the VIX Mar 25 Calls at 2.62.  The spread was completed when they purchased the VIX Mar 18 Puts at 0.57 and purchased the VIX Mar 27 Calls for 2.19 with the result being a credit of 1.26.  The ultimate goal, if held to expiration, is for March VIX settlement to fall between 20 and 25.  So far in 2016 we have only eighteen trading days behind us, six of those days VIX has closed over 25.00 and only once VIX has closed lower than 20.00 so for about 2/3rds of trading days we have seen a closing price that the seller of this spread would consider a good place to be.

VIX PO 2

 

One final note – I know I didn’t include the March VIX futures in the payoff diagram, that’s because spot VIX and the March contract are trading almost in line with each other at this time, but always be aware the better of the two to value VIX options is the corresponding VIX future and not spot VIX.

Paper by Professor Bondarenko Has Intriguing New Analysis of PUT and WPUT Indexes

Jan. 27, 2016 – A new 10-page study examines both the CBOE S&P 500 PutWrite Index (PUT) and the CBOE S&P 500 One-Week PutWrite Index (WPUT), comparing their performances with that of traditional benchmark stock and bond indexes. This is the first comprehensive published study that examines the performance of a benchmark strategy index that incorporates Weeklys options. Written by Oleg Bondarenko, professor of finance at the University of Illinois at Chicago, the study — “An Analysis of Index Option Writing with Monthly and Weekly Rollover”– analyzes the performance of the two indexes through the end of 2015.

The new paper discusses 19 Exhibits. In this Blog I highlight 5 of the Exhibits.

1. HIGHER AGGREGATE GROSS PREMIUMS USING S&P 500® WEEKLYS OPTIONS

CBOE introduced Weeklys options in 2005. In the initial years of Weeklys trading, it appeared to me that some observers thought that Weeklys might be used primarily by retail speculators, but in recent years I have heard from multiple institutional investors that they are writing S&P 500 Weeklys options for the purposes of prudent income enhancement. The new study found that, from 2006 to 2015, the average annual gross premium collected was 24.1 percent for the PUT Index and 39.3 percent for the WPUT Index. While a one-time premium collected by the weekly WPUT Index usually was smaller than a premium collected by the monthly PUT Index, the WPUT Index had higher aggregate annual premiums because: (1) premiums were collected 52 times, rather than 12 times, per year, and (2) time decay (or theta) usually works in favor of the WPUT Index vs. the PUT Index.

1 - Premiums PUT WPUT
2. PUT INDEX HAD HIGHEST RETURNS SINCE MID-1986

In the period from mid-1986 through the end of 2015 –

  • (1) The total % growth for benchmark indexes was 1622% for the PUT Index, 1499% for the S&P 500 Index, and 646% for the Citigroup 30-year Treasury Bond Index; (all of the indexes (except the VIX® Index) in this Blog are total return indexes), and
  • (2) The annual compound return of the PUT Index was 10.13 percent, compared with 9.85 percent for the S&P 500 Index.

2 - long-tern line PUT

3. DRAWDOWNS WERE LESS SEVERE FOR PUT AND WPUT INDEXES (COMPARED TO S&P 500)

From 2006 through 2015, the worst drawdowns were down 24.2 percent for WPUT, down 32.7 percent for PUT and down 50.9 percent for the S&P 500.

3 - Drawdown PUT WPUT
4. HIGHER RISK-ADJUSTED RETURNS FOR PUT INDEX

Over a period of 29½ years, the PUT Index had higher risk-adjusted returns (as measured by the Sharpe Ratio, Sortino Ratio, and Stutzer Index) than the S&P 500, Russell 2000, MSCI World, and Citigroup 30-Year Treasury Bond Indexes. However, please note that many risk-adjusted return metrics assume a normal distribution with no skewness, but there was negative skewness for several indexes, including PUT (-2.09), S&P 500 (-0.79), and Russell 2000 (-0.89).

4 - Sharpe Sortino

5. SOURCE OF RETURNS – RICHLY PRICED SPX OPTIONS

An inquiring investor might ask – how could the PUT Index have higher returns and lower volatility over a period of almost three decades? A key source of returns for sellers of SPX index options has been the fact that, according to Exhibit 5, these options have been richly priced in all the years since 1990 (except in 2008).

5 - Rich Pricing

MORE INFORMATION

For links to the new paper and to several other options-based strategy papers, and to data and information on the PUT and WPUT indexes, please visit www.cboe.com/benchmarks.

VIX Options and Futures Review – 1/24/2016

The stock market rally on Friday put pressure on VIX and pushed the spot index down enough that the front month February future closed at a slight premium.  This is the first premium for the front month VIX futures relative to spot since January 4th.  I’ll discuss this a bit more toward the end of this blog.

VIX Long Term Curve

 

The generic short dated curve flattened out which I’m learning is the normal shape using the five consecutive weekly VIX futures contracts.

VIX Short Term Curve

 

As mentioned above, with Friday’s price action VIX is now at a discount to the front month future.  The result here is an end what goes down as the eighth longest streak of spot versus front month backwardation.

Friday Spot - FM

 

Another measure of backwardation and the one the VIX ETP traders care the most about involves the front month versus the second month futures.  February VIX actually closed higher than the March contract.  In fact every day in 2016 the front month has closed higher than the second month.  This run of backwardation is up to fourteen days.

Friday FM - SM

 

Finally, since VIX moved below February, this put an end to backwardation when comparing spot VIX, the front month, and second month futures price.  All the stars have to align for this measure of backwardation and this ended up being the third longest streak of backwardation on record.

Friday - Spot - FM - SM

 

Volatility Indexes and ETPs Review – 1/24/2016

The S&P 500 rebounded by about 1.4% last week and SPX option volatility moved a bit lower.  The VXST – VIX – VXV – VXMT curve shifted lower and flattened.  However for a bit of perspective I show where we ended 2015.  I think the comparison is a good indication that we may not be completely out of the woods, at least based on the expectations indicated by the various S&P 500 oriented volatility measures.

VXST - VIX - VXV - VXMT

 

The rebound in the stock market put some pressure on VXX with fund losing over 6% last week.  Do not fret for anyone who purchased VXX at the end of 2015, as they are still up about 25% on the year.  Although few (if any) traders take a buy and hold approach with VXX.

A couple of other things on this table caught my eye.  VVIX remains pretty high, just a tad under 100.  In calmer times VVIX is usually in the 70’s (or lower).  SKEW in the 130’s indicates demand remains for out of the money SPX puts despite the strength of stocks this past week.

VXX Table

 

Mid-day on Friday the biggest VXX block trade of the day was executed.  With VXX at 25.74, 0.74 higher than the close of the day, there was a buyer of 10,000 VXX Jan 29th 21 Calls at 4.78 who sold the VXX Jan 29th 24 Calls for 2.14 paying 2.64 for this call spread.  The annotated payoff diagram appears below.

 

 

As long as VXX closes above 24.00 the result will be a profit of 1.36 and if VXX completely tanks, which would mean a huge rally in the S&P 500, and closes under 21.00 the result is a loss equal to the debit of 2.64.  Note I also highlighted where VXX was when the trade was executed and where it closed.  There is still a 1.00 cushion before the trader may consider their alternatives, but that is 0.74 less than when they executed the trade.

Be Cautious When Using VIX vs. Oil as a Market Indicator

I awoke this morning to an email from the matriarch of CBOE-TV Holly Goodhart.  She was preparing for her day with CNBC on in the background and something caught her eye.  The following comes directly from her email –

I have CNBC on this morning, and they just spent a segment discussing this headline:
“Markets bottom when VIX is greater than oil.”

This didn’t sound right to me for a few reasons, primarily because I recall many years with the price of oil in the teens.  Yes, I’m old.  However, since I love playing with numbers I got to work looking at the closing price of Oil versus VIX and gathered as much data as I possibly could get my hands on.  For the price of Oil I used the daily WTI Cushing, OK number from the EIA and for VIX I used VIX from 1990 to present and to get a little more history I used VXO for 1986 through 1990.

The result is daily data for 30 years.  As I was compiling and checking the data for errors I noticed that VIX and Oil were priced in line with each other on a pretty consistent basis.  This was going on even through parts of the 1990’s.  The table below shows that the average for VIX has actually been higher than for Oil several years and even as recently as 2002.  Years where the average price of Oil was lower than VIX are highlighted in red.

Oil VIX Average

 

This next table shows the number of days by year that VIX closed higher than Oil.  From 2004 to 2007 it never happened.   Then in 2008 VIX closed higher than Oil for the first time in year on October 22, 2008 with the S&P 500 at 896.  VIX remained at a higher level than Oil for 82 trading days (with some gaps) through March 11, 2009 when the S&P 500 closed at 721.

VIX Greater than Oil

 

After putting these tables together I decided to take a look at the CNBC article to see what they were saying.  The article notes that the last two times VIX closed higher than Oil were August 24, 2015 (big surprise) and March 11, 2009.

My first issue with this is if you are using VIX versus Oil as a signal for a market bottom then when this happened on October 22, 2008 you would have considered that a bottom, it’s easy in retrospect to say we should have bought in March 2009 since that was the last time VIX was greater than oil.  The price chart below is a daily two year chart of the S&P 500 beginning on the first day VIX closed higher than Oil.  I put a box around the time period where VIX was consistently higher than oil.

SPX 2008 2010

 

Note that using the first occurrence of VIX closing over Oil would have gotten you in pretty early.  Knowing that the last time this would happen was in March is great hindsight, but at the time would not have been a viable signal to trade on.

The other occurrence noted in the article was August 24th.  We had a one day VIX over Oil close and that was it.  The chart below is the daily price action from August 24th through last Friday.  We have basically done a round trip in the S&P 500 since then.

SPX 2015

 

With the markets in turmoil many market forecasters will try to call a bottom in the S&P 500.  When they cite data be cautious and do some work.  In this case long term history says that VIX higher than Oil doesn’t tell us much at all.

Current VIX Backwardation Streaks in Context

When VIX is relatively high the VIX term structure moves into what we commonly refer to as backwardation.  The way this may be defined varies among market participants, but most focus on the shorter end of the VIX curve.  That is what I’ve been doing lately as well.  It turns out, regardless of how you define VIX backwardation 2016 has experienced more instances of it than not for the first ten days of 2016.  The tables below rank the consecutive day streaks for VIX backwardation by using three different ways of defining the relationship between spot VIX and VIX futures or even between VIX futures contracts.

The simplest definition of backwardation might be when spot VIX closes higher than the first month future.  With the exception of the first two trading days in 2016 spot VIX has closed at a premium to the first month (January 2016 VIX) each day this year.  As of Friday the current streak is at eight days, which places this run in a tie for 12th place.

Spot FM

 

Many volatility derivative traders like to focus on the relationship between the first month and second month.  That is due to this relationship having an impact on the VIX oriented ETPs (VXX, SVXY, UVXY, etc).  Currently that is the January 2016 and February 2016 VIX futures contracts and January has closed higher than February for all ten days in 2016 which puts this ten day run just inside the top 10 of backwardation streaks.

Spot FM SM

 

Finally, a more rigorous definition of backwardation would involve spot VIX closing at a premium to the first month and the second month closing below the first month.  This has occurred each day since January 6th for a streak of eight consecutive days which is tied for 7th place among backwardation streaks.

Spot FM SM

 

I put up a ten minute video expanding on VIX backwardation and discussing these various streaks a little more.  You can view that at the link below and keep an eye on this blog site as we track the current streaks for each of these methods of defining VIX backwardation.

Checking on the Current VIX Backwardation Streak 1/15/2016

VIX Options and Futures Review – 1/17/2016

Two tomatoes are walking down the street, momma tomato and baby tomato.  Baby tomato can’t keep and momma tomato keeps getting angrier and angrier.  Finally she stops, turns around and stomps on baby tomato.  She then states, “Catch up”.

That’s what the VIX futures did this past week, with the stock market playing the role of baby tomato and getting stomped on.  When the dust settled this week VIX was actually up by 0.01 with VIX futures narrowing the gap.  January, which settles on the open this Wednesday, gained 4.75% closing at a slight discount to spot VIX.

VIX LT Curve

 

The theme for the short term VIX chart below is “The Twist” as the generic charts were lower or higher depending on the time frame.  In general the angle of the curve remained pretty much the same.

VIX ST Curve

Mid-day Friday there was a trader who came in and purchased about 25,000 of the VIX Jan 35 Calls for 0.33.  This occurred with VIX around 28.10, higher than where we finished the week.  The payout at January settlement, which again is this Wednesday morning shows up below.

VIX PO

 

Volatility Indexes and ETPs Review – 1/17/2016

In an interesting twist VIX was the underperforming index across the VXST – VIX – VXV – VXMT curve rising only 0.01 last week. It is unusual for VIX to be an outlier like this, but even more so when we experience a three day weekend which one would expect to put some pressure on VXST relative to the longer dated volatility indexes.

VXST VIX VXV VXMT
VXX rose about 7 ½% last week despite the paltry 0.01 gain in VIX. We all know that VXX is not VIX or even any sort of direct exposure to spot VIX. VXX is a consistently rebalanced portfolio focusing on the front two month VIX futures contracts which until this coming Wednesday consists of the January and February contracts. January VIX rose 4.75% last week and February was higher by 5.53%. However, January closed at a premium relative to February every day last week which added to the VXX performance as what is called the roll yield (and is usually a negative experience for VXX performance) was very much a positive.

SKEW and VVIX finished the week at elevated levels, although VVIX was down slightly. Both are indicators of concern about downside for the equity market so both are showing many market participants believe there is more to come despite the worst ten day start for the stock market on record.

VXX Table

What has been good for the long ETPs has been a catastrophe for the short funds, for example SVXY is down more than 28% in 2016. It appears to me that someone may be expecting more downside from SVYX. Late Friday with SVXY at 36.01 there was a seller of 500 of the SVXY Mar 18th 25 Calls for 12.50. This trade took in 1.49 of time value but for the most part is a short play on short volatility (negative times a negative is a positive so it’s a play on long volatility as well). It is possible the trader also holds a large long position in SVXY and is hedging the trade by selling a deep in the month call. Either way this shows worry that what we have experienced to start 2016 may be expected to continue, at least for the next few weeks.

SVXY PO

VIX January 22 / 30 1 x 2 Call Spread from Monday

Today, while I was teaching at the Options Institute, a roar came up from the VIX pit about an hour into the trading day.  Despite the tumultuous market activity that we have experienced to begin the year, the audible volume from the open outcry pits has been fairly tame.  What got the guys going today was a very large ratio spread using January VIX Calls that expire on the open next Wednesday.

The specific trade sold well over 100,000 of the 22 Calls and purchased twice as many of the 30’s.  To bring things down to a workable visual let’s just say they sold 1 VIX Jan 22 Call at 3.35 and then purchased 2 VIX Jan 30 Calls for 0.95 each.  This results in a credit of 1.45 for each 1×2 spread.  At the time VIX was near 25.50 and the January futures trading at a small discount to spot VIX.  The payout at January 20th VIX settlement appears below.

VIX 1 x 2

 

This trade works if one of two things happen – either a drop below 22.00 where all options expire out of the money or a big rally to the upper 30’s.  Of course a big move in either direction may result in this trade being taken off early.  I’ll be watching those two strikes for the next week or so to see how this one may be managed.

VIX Options and Futures Review – 1/10/2016

The VIX curve moved from flat to backwardation as the S&P 500 dropped almost 5% to begin the year.  We finished the previous week with the curve pretty flat which is often considered an indication of uncertainty among volatility traders.  As a stretch of a visual I think about a flat volatility curve replicating a ‘fair coin’ which is the proper academic way to introduce a true 50 / 50 prospect.  That coin toss turned out to be extremely bearish for the equity markets this past week.

VIX Curve + Table

 

The short term VIX curve is often very flat since the near dated VIX futures tend to follow the performance of spot VIX fairly closely.  That has been the case except when we get a spike in volatility like last week.  Just like the more established VIX curve above, the short dated futures are in backwardation.

VIX ST Curve + Table

 

We have short dated futures on VIX and short dated options as well.  Both have caught on very quickly, and the trade from this past week uses two of those expiration series to create a VIX put calendar spread.  The biggest block trade on Friday involved a seller of the VIX Jan 27th 16 Puts at 0.11 who the purchased the same number of VIX Feb 3rd 16 Puts for 0.18.  A payoff diagram is tough for this trade since both options have different underlying pricing instruments.  My thinking is the trader expects one of two things.  Either they expected the Feb 3rd contract to maintain enough value at Jan 27th expiration so this trade turns a small profit or they are trying to thread the needle expecting Jan 27th VIX settlement over 16.00 and Feb 3rd VIX settlement below 16.00.  In this case I am leaning more to the first thought than the second though.

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