Long vol through short ITM VIX puts

[guspenskiy13]

Then, unless your are buying really flat term structure, the roll down will kill ya

The "roll down" and "will kill"? Not sure what you mean - any sold put that "covers" losses up to 11.5 or so...the maximum loss would be capped at 11.03 (lowest settlement)...

So, let's say we have 12P at 0.50; your max gain is capped at $50 per contract - max loss is capped at $50 per contract...with enough DTE you don't even need to hold until the expiry.

 

[guspenskiy13]

Just a cusrosry look, I find it hard to believe the MAR 12.50 put was @ $1.00 on that date looking at historical prices.

 

[guspenskiy13]

This strategy is very similar to selling TLT puts when you felt you wanted to be long bonds as a form of protection. The key difference is that usually the forward drop as well as the skew is in your favour on TLT and against you on VIX.

Thanks for this information, I was actually looking at doing some fixed-income with lever....

 

[sle]

The "roll down" and "will kill"? Not sure what you mean - any sold put that "covers" losses up to 11.5 or so...the maximum loss would be capped at 11.03 (lowest settlement)...

Simply that the futures reference for the put will be higher then the realization of spot and you will be a payer of that bleed. So it might get painful, see below for my thoughts on VIX put tails too.

Also, I am pretty sure we've had sub-10 prints before 2008 and we had a 10.65 print on a weekly futures this January, so considering 11.03 the absolute floor might be risky.

So, let's say we have 12P at 0.50; your max gain is capped at $50 per contract - max loss is capped at $50 per contract...with enough DTE you don't even need to hold until the expiry.

They barely decay (due to the vol rampup), so you will find yourself holding them for a long time. Which means you want a rally in vol when you can monetize your MtM gains. If you manage to sell them at a really attractive break-even, it's a worth while trade but don't forget that you are selling a "probable outcome" meaning it's more likely that your put will be ITM (that's why risk/reward looks so attractive on paper). For example, out of all expirations (217 of them), 30 expired under 12.

I am not trying to rain on your idea, just trying to give you some risk factors (since I have actually tried this myself). YMMV, as they say.

 

[sle]

Thanks for this information, I was actually looking at doing some fixed-income with lever....

You're welcome. This trade (long equity via long index calls, long bonds via short bond puts) worked very well when rates were higher, so we might be back to the environment where it makes sense. I'd just avoid doing it during the fed hiking cycle, bond/equity correlation breaks down a touch during these periods.

 

[Gambit]

The motivation for the trade is pretty clear - he wants to be long vol while not paying excessive risk premium. This is also known as "have the cake and eat it too; and fuck the baker while at it".

Theoretically, it's probably possible to find a situation when VIX is cheap at that forward while vol of vol is expensive, but I have only seen that once or twice. As I said, the key problem is that your vol of vol exposures will be a powerful offset to the long vol delta.

Ps. Do we want to have a more detailed conversation about vol of vol dynamics?

Sle, I've seen an investment bank white paper that recommended shorting vix puts and going long an otm call in the same expiration. In that case wouldn't that primary vol of vol risk be hedged? But of course, I'm sure there are other issues.

 

[sle]

Sle, I've seen an investment bank white paper that recommended shorting vix puts and going long an otm call in the same expiration. In that case wouldn't that primary vol of vol risk be hedged? But of course, I'm sure there are other issues.

It's a bank while paper, do you expect wisdom from it?
In short, this trade (a risky) flattens your vov vega, but your have to sacrifice the strike differential or do it ratio. Again, the issue of cake and the sexy baker comes up.

It might work if you catch a very flat and low curve - just so hard to do and if you see something like that, simply buying futures or a call might be easier

 

[newwurldmn]

If you are going to buy vol, bet on the gap event. Don't limit your potential unless you are handsomely compensated for it.

Otherwise it's tough to justify the theta/carry/slide/whatever you will pay.

 

[guspenskiy13]

They barely decay (due to the vol rampup), so you will find yourself holding them for a long time. Which means you want a rally in vol when you can monetize your MtM gains. If you manage to sell them at a really attractive break-even, it's a worth while trade but don't forget that you are selling a "probable outcome" meaning it's more likely that your put will be ITM (that's why risk/reward looks so attractive on paper)

I agree on decay and that it's mostly a "hold until the expiration". I also think that they are priced like this for a reason...The so-called "floor price" is a big factor, which made this look appealing to me.

In terms of the "floor", yes, there is plenty of data up to pre-GFC period. However, I tend to focus on at least 2011+ period, because the VIX complex has evolved dramatically since those times...the magnitude of the spikes has certainly increased, so as vol-of-vol...plus the contagion into various S&P500 instruments, which creates a self-reinforcing cycle.

bond/equity correlation breaks down a touch during these periods

Good point...overall, I think that correlation of bonds to equities is a rather major theme moving forward. They are not always negatively correlated during the panic, as people tend to think.

You're welcome. This trade (long equity via long index calls, long bonds via short bond puts) worked very well when rates were higher, so we might be back to the environment where it makes sense. I'd just avoid doing it during the fed hiking cycle, bond/equity correlation breaks down a touch during these periods.

Offtopic...I wanted to make a different thread, but just out of curiosity - what do you think of buying heavy-levered baby-bonds of stable, low-beta companies? I've tried to find some information, but didn't find much. There are companies with 8.0% yields, very strong credit and NR baby bonds...seems as a non-brainer to me...general illiquidity and 'lack of popularity'/knowledge of the industry make this even better IMO...

Sle, I've seen an investment bank white paper that recommended shorting vix puts and going long an otm call in the same expiration. In that case wouldn't that primary vol of vol risk be hedged? But of course, I'm sure there are other issues.

I would love to see this paper.

 

[guspenskiy13]

If you are going to buy vol, bet on the gap event. Don't limit your potential unless you are handsomely compensated for it.

Otherwise it's tough to justify the theta/carry/slide/whatever you will pay.

Honestly, I have simply viewed selling ITM puts as betting on slightly higher vol/settlements >13, without paying anything for it.

With this type of "ambiguous view", selling May 12P for 0.35 makes a little more sense, than buying 15-17 for 1.7/1.3. Just probabilities IMO.

Therefore, the compensation seems to be more than fair. Look at /VX prices since mid-Oct...lots of premium would be burned, offsetting any potential compensation at this point.