Take Advantage of Cheap VIX Calls

01/14/2014 9:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

With IV so cheap these days, Mark Sebastian of OptionPit.com thinks that taking a flier on some cheap calls make sense.

Since the end of the congressional stand off, the VVIX (the vol of VIX) has done one thing: plummet. For a brief period, VIX vol hit periods in the 50's, levels not since these options listed in the mid 2000's. Take a look at how low 30-day IV has gotten in VIX options.

This can sometimes be equated to the market being “complacent,” which to be honest, the market has been for the last year. However, its been with good reason: not much has happened. VIX has not moved much above 17 in about a year, and has had trouble breaking 15%. If one were to take the 'mean' of the VIX since Jan 1 2012, it would put the VIX somewhere near 14%.

chart
Click to Enlarge

One thing to recognize is that the VIX SHOULD have IV's dropping as it falls, much like the SPX sees IV's fall when it rallies (Just like SPX and VIX, VIX and VVIX are somewhat negatively correlated. That being said, there is a level where IV's just cannot go much lower. For SPX, that level is around 11%, for VIX that level is around 60%. When VIX hits 60%, the options are almost always a purchase.

The Trade
Call spreads in VIX are super cheap, and take advantage of skew in VIX options. That being said, there is a TON of activity in March, April and May upside VIX options. With IV so cheap, I think a flier on some cheap calls make sense. Another trade that could work is a well placed Feb straddle. There are plenty of chances for vol to move in the next month. The stuff is cheap, buy it when you can, not when you have to.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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