VXX - How the Options Market Isn't Buying the Rally

Discussion in 'Options' started by livevol_ophir, Sep 9, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    VXX (VIX Short-Term Futures) is trading $18.72, with IV30&#8482 down 3.5% to 66.32.
    <img src="http://3.bp.blogspot.com/_hMry1m7UF10/TIkuadTSkLI/AAAAAAAAEqU/glj9Lv8o_rc/s1600/vxx_summary.gif">

    So the market is up, vol is down and VXX is super down over the last few months from 31.66 down to 18 (ish). The Charts Tab for the recent few months is included (<a href="http://livevol.blogspot.com/2010/09/vxx.html">in the article</a>).

    <img src="http://3.bp.blogspot.com/_hMry1m7UF10/TIkua_bYKAI/AAAAAAAAEqc/rrqJSPHCeSA/s1600/vxx_charts.gif" width="450">

    During this same time period, the market hasn't been ripping, it's just been bouncing. I've included the S&P 500 chart for the last few months (<a href="http://livevol.blogspot.com/2010/09/vxx.html">in the article</a>)., note the horizontal line on top illustrating where the market has bounced back down ff of cyclical highs.

    <img src="http://1.bp.blogspot.com/_hMry1m7UF10/TIkvjwXSAoI/AAAAAAAAEq0/eZITXOJgbLo/s1600/spx_charts.gif" width=450">

    So vol has declined in a period where the market has muddled around, it has not been a matter of a market headed straight up. The question isn't so much where we've been, but of course, where we're going. Let's look at the VX Skew on 7-21-2010. It's just a random date I chose over the last few months is pretty representative of the skew shape over this time frame (<a href="http://livevol.blogspot.com/2010/09/vxx.html">in the article</a>).

    <img src="http://3.bp.blogspot.com/_hMry1m7UF10/TIkubOFfftI/AAAAAAAAEqk/_FotSLCeSBQ/s1600/vxx_skew_7-21-2010.gif" width="450">

    The skew looked quite flat, indicating an option market implication of lessened tail risk. And, as we have seen, this implication was correct over the short term. Now let's take a look at the VXX skew as of yesterday (<a href="http://livevol.blogspot.com/2010/09/vxx.html">in the article</a>).

    <b>Whoa....</b> We can see now that the VXX skew is pronounced and steep relative to the mid summer. A part of the muted skew in July was a summer doldrums, where vol often drops. The point now is that as the market is reaching it's cyclical/technical highs, this time, the VXX skew is pricing substantive tail risk. In other words, the option market isn't buying the recovery relative to summer. Hmm...

    Note also, the overall level of IV30&#8482 for the VXX is 65.62. For perspective, the 52 wk range is [55.91, 93.11]. So, while skew is expensive, vol is relatively cheap.

    This is trade analysis, not a recommendation.

    Details, trades, prices, vols, skews, charts here:

    Legal Stuff:
    <a href="http://www.livevolpro.com/help/disclaimer_legal.html">http://www.livevolpro.com/help/disclaimer_legal.html</a>
  2. ....i find it strange that these posts dont get many comments...even though i havent commented myself,( i havent because they seem a little over my option pay grade)....

    i am interested in the vxx however, i posted a possible credit spread on another thread, ....juicy....

    vxx, oct 18/19p

    vxx was 20.63 when the trade was originally recommended last week, it looks like we need to come down on the strikes, vxx 18.94 today....

    any thoughts?
  3. livevol_ophir

    livevol_ophir ET Sponsor

    I can't really give any specific recommendations. I would say this:
    If you think the vol is low and going higher, and the skew is also high, there is a nice opportunity to buy ATM options and sell wings. That would be a low vol purchase (ATM) and a high vol sale (skew is steep).

    A more aggressive trade could be to do a 1 x 2. That trade sells elevated skew (if you think it is elevated) twice. Since VXX moving up is related to a market downturn, that's the side that skew rises on. Of course, 1 x 2 is a big margin hit naked options on a big move. I hope that gives you some stuff to think over.