lystn

Hey everyone, Kirk here again and welcome back to the daily call. On today’s call, we’re going to talk about VXX and VIX options and how you should trade them. I’ll make this short and say we’ve done a podcast before on volatility options in these two, so if you want to understand the entire process and procedure for how they’re priced and how they work, you can definitely check out those other podcast. Head on over to optionalpha.com/podcast and just search in there. But the whole idea with these two is that they both are volatility type products that have options on them. It’s a pure way to trade volatility, most notably in the SaP 500. The VIX really tracks SaP 500 volatility. It’s a broad-based, broad market, a way to trade or play volatility. The best way in our opinion to trade VXX and VIX is to trade them bearish or to trade them once they’ve had a spike higher. What we typically would do just to lay out an easy framework or a process you can follow is that if implied volatility on the VIX spikes from 15 to 25, then we would short the VIX and try to profit from a directional move lower in volatility, just this concept that if volatility spikes, we know that most often or more often than not, those quick spikes in volatility have a tendency to fizzle out over time and volatility consolidates or averages back to the mean or collapses and so, we play that directional move. The thing you have to understand about volatility options is that the market knows that as well. Those options are priced a little bit more aggressively. When implied volatility is high, the market prices in the fact that over time, volatility should go lower. Same thing in the inverse. When volatility is really low, option prices assume that at some point in the future, the further you go out that volatility at some point will go higher. There’s no necessarily arbitrage that you can get out of buying options on the VXX or buying options on the VIX when volatility is low or high. It’s all priced in. But here’s the thing. When volatility spikes up higher, what happens more often than not is that it does go down over time. There is an opportunity to profit if you are willing to take a short position in volatility, meaning you’re betting that volatility will collapse, that the markets maybe will rally at some point and this usually happens after maybe a little bit of a selloff or a correction in stocks. What I know is that I have not traded them as aggressive as I should’ve been. Honestly, when we go back and start looking at all of the data for all the VIX trades, it’s one of the highest, most profitable trades that we do and we just don’t do enough of them because I’m always fearful (to be totally honest) that a spike up in volatility will be followed by another spike up in volatility. But what I need to start doing (this is me, self-confessing on this podcast to what I’m learning about myself in trading and how I look at things) is I need to be more aggressive into putting on bigger positions in VIX and VXX when volatility does spike up because if I look back over the last couple of years of trading this, the spike ups that it’s had, whenever it’s had them a couple of times a year, they’re usually followed shortly after 10, 15 days maybe at some times of contraction in volatility. It’s rarely followed by a black swan event. Now of course, just to be fair, we don’t know when the next black swan event is going to happen, conceivably because maybe that’s just my luck, maybe the next time I put on a VIX trade and I go a little bit more aggressive, a little bit more short and bearish, then the next black swan event happens. Of course, I’m going to keep my position size at that 5% threshold that I talk about so often, but I am going to start trading those a little bit more aggressively for sure when we get those next volatility spikes because they’re just so darn profitable. I don’t want to overtrade them. That’s the key here. I don’t want to overtrade them, but when volatility spikes up and you have an opportunity to short it, it should be a “very, very easy, easy trade for you to make.” One of the trades that we recently did was the VIX spiked up and then we ended up trading out basically the one month out. They’re about September options at the time we’re doing this recording. We bought a put debit spread. We bought the 16s, sold the 14 puts. We went directional with a put debit spread and we bought that for 145 and now, it’s trading up around 175 in literally three days. It’s ridiculous. We bought five of those, so that’s good. We did a bunch of contracts, but we could’ve done probably like 30 or 40 contracts realistically and we should’ve done much more. Maybe it wasn’t 30 or 40 right off the bat, but maybe we did 25 for the first round and then just to make sure if volatility went up even higher, we added more to it and could’ve traded it lower. That’s something I’ve definitely learned about myself in trading volatility just over the past couple of years, is I definitely know that more often than not, volatility contracts and goes down over time, so trade those contracts a little bit further out in time, give yourself some time for the markets to consolidate and move back lower, but definitely try to be more aggressive on the volatility trades. We definitely will and we’ll do them always risk-defined. We won’t ever do them undefined risk. We don’t want to leave ourselves open to that much of risk in volatility. But if we do them risk-defined with a debit spread or a credit spread, however you want to play it, I definitely say go a little bit more aggressive. Hopefully that helps out. As always, until next time, happy trading!