Option trader Mark Sebastian, of OptionPit.com, explains how the recent movement of the VIX may have been throwing off contango traders and why it’s important to watch for shifts in the curve, not just percentages of contango. He also offers an options play as a hedge of volatility.
One of the things that has been throwing off the VIX, VXX, and XIV contango traders has been how the VIX has been moving. Where—in October and December—we saw VIX swing back and forth some, since the beginning of January, VIX moves have not involved a lot of backwardation. Instead, we are seeing moves in parallel: essentially, the whole curve is moving as one unit. Take a look at the movement we have seen week over week in VIX:
www.vixcentral.com
Click to Enlarge
Notice that while VIX is substantially higher, the curve itself is still holding shape. The problem for long VXX is that the curvature has caused the index not to rally quickly, UVXY is even worse. For XIV, the vol moves and the daily tracking have caused that ETP to perform poorly as well. For VIX option and Futures traders, the moves have been slow trends not pops, making the movement hard to trade and fade.
The Lesson:
Pay attention to more than simple contango, watch for shifts in the curve, not just percentages of contango.
The Trade:
I think the best play might be to use VIX and VXX as hedges of vol against SPX straddles and strangles. I would rather own realized vol than implied.
By Mark Sebastian, Blogger and Contributor, OptionPit.com
