Volatility question

Hey guys,

A while back y’all told me that buying VIX calls just because it’s “low” is a bad idea. I can’t remember exactly who it was that mentioned this, but it was something about how VIX is calculated that means it always erodes value.

Can I ask you to dive in deeper here? Or maybe point me in the right direction?

Vix works buy buying a shit ton of contracts on the S&P, there’s a mathematical way to construct it, but you can look it up.

The massive losses come from the theta on short-term options

You’re probably thinking of VIX futures, which decay away because of contango in the term structure. VIX calls are options directly on the VIX, and so don’t have that feature.

I short VIX futures, and trade calls (buying out-of-money calls is good protection), but never long futures (or VXX).

But aren’t those options priced using the futures?

I bring it up because someone recently shared an article via Facebook about some dude who spent about $130k to buy $0.50 contracts on VIX with a strike of 22.00 expiring next month (standard monthlies).

and I tried to chime in that this was a really dumb move - hence all the contango. I tried to offer the idea that it’s not impossible this trade pays off, but if it does the guy better not be claiming anything other than luck. Or that it’s an insurance policy for his portfolio.

Also. So you really are PA huh?

that sounds like incredibly expensive insurance. he’s basically betting on a black swan occurring and this trade will only feel good if the market freaks out and experiences an '87 type event. he could get lucky and make 2-4x his money if a whole whack of political and bad economic news hits the wire in early jan but the trade probably has a 95%+ chance of total loss given the short time period. also, early jan is typically one of the strongest periods for the market so seasonality is not on his side.

i’m fine with bets like this and have done them in the past due to various factors but none of those factors are in place at the moment, for me at least, and i would never bet $130k on this. maybe a grand or two with the prospect of a 100x payout if things worked out as planned. he better have $10M or else $130k is just silly.

I agree with you entirely.

Here is the article. https://www.bloomberg.com/news/articles/2019-12-17/big-vix-call-options-trade-suggests-re-emergence-of-50-cent

I had it wrong, it wasn’t a $130K trade, it was 130,000 contracts. So it actually cost him about $6.5mill

I just checked Etrade, you can see there’s about 220K contracts out there now. The Jan 22nd $22 calls.

pro trader though. a bit of a different game as a pro trader. you don’t know what other huge trades he has online right now…

I think VIX calls are interesting right now.

This week I bought 5 month calls @ 30, and paid for them by selling 1 month calls at 20. If nothing happens immediately after this fake trade deal, I’ll have a free hedge and profit opportunity till May 2020 (in the last five years VIX 50 has happened twice). If something happens and VIX closes above 20 in January, I’ll just short VIX futures and ride it down (hedged at 30). I would short that spike anyhow (hey, we are backed by the full force of the US govt market-pumping machine), but I’d rather get paid a free hedge to do it. Now I’ll sell 1 month calls for the next 5 months while waiting.

Dunno about that guy’s trade, depends on portfolio context. But it seems like a big bet on a short maturity.