Since Donald Trump won the US presidential election on November 8th, 2016, equity markets have been in a euphoric state.
And as most tastytraders are well aware, upward movement in global stock prices generally translates to downward movement in the CBOE Volatility Index (VIX). The VIX can rise when markets go up, but it's more rare - as detailed in this previous episode.
So as US volatility traders sat down to dig into their Thanksgiving turkey last week, it was likely with a side of mashed VIX, instead of the usual potatoes.
After a steady rise in late October from roughly 13 to 22, the VIX has followed its recent pattern of falling quickly back to earth whenever it looks like it might finally break out into a sustained rally. The VIX now sits around 12 and change.
The interesting aspect of this particular VIX crush is that stocks are actually moving quite a bit right now (although mostly to the upside). So while traders may be winning with short volatility bets, it's likely many have also felt the pain of chasing deltas - especially if trading a delta-neutral strategy.
Delta neutral trading, as described here, basically means that you've traded stock against your option position to help minimize directional risk. When stocks move a lot, even when volatility gets compressed, traders can lose money chasing their deltas as they attempt to maintain their delta-neutral hedges.
The chart below from a recent episode of Options Jive illustrates how indexes across the board have made significant moves since the election:
If you believe the trends pictured above could continue in the near term, or even reverse altogether, then you may be looking for trade structures that leave your portfolio less exposed to delta movement.
If that is the case, another recent installment of Options Jive may be just what you've been searching for.
The title of this episode, "Trading Volatility, Not Price," is a fairly clear indicator of what you’ll find within.
On the show, long-time hosts Tom Sosnoff and Tony Battista discuss in greater detail how a winning mean-reversion trade can get flipped into a loser through the delta component. They go on to explain how variance swaps are a great way to trade "pure volatility," but quickly indicate that these structures are traded OTC (over-the-counter) and are therefore not accessible to most traders.
The answer, they suggest, for traders seeking "pure" volatility play is to trade the VIX directly - through call spreads and/or put sales.
As the VIX hasn't been able to sustain levels above 20 for any meaningful amount of time in recent history, one potential trade structure they outline on the show is an upside call sale in the VIX. In order to cap losses in the event of a VIX spike, they also suggest buying an OTM (out-of-the-money) VIX call above the strike that you sold to reduce tail risk.
This trade structure could theoretically be implemented when volatility has been steadily increasing, and you want to leverage a potential reversal.
Tom and Tony also explore put sales in the VIX when volatility has been steadily declining. Because there's a finite limit to the downside when selling VIX puts (VIX can't go below zero), they don't necessarily suggest buying lower strike VIX puts for protection.
The slide below outlines the two trades outlined above that can be utilized to exploit "pure" volatility reversion in the market, without the delta/directional risk that accompanies option trades hedged with an underlying:
While the above trades may not fit your strategic approach and/or risk profile at this time, it's possible that one of them may become more attractive in the future, or under different market conditions.
If you have any questions or comments on these topics we hope you'll follow up at firstname.lastname@example.org or leave a comment below.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.