Last week I got received a research report from Bank of America Merrill Lynch that led with the introduction of the BofA Merrill Lynch VIX Calendar Strangle Index. This index depicts the performance of a strategy that will purchase VIX put options that expire 3 months out and are 2.5% out of the money and simultaneously buy 4th month call options that are 20% out of the money. These positions are established each month on a date that is half way between the 3rd and 4th month expiration dates. Two months later these option positions are rolled. Also, there are actually concurrent positions held in two different pairs of outstanding options.
The index was designed to demonstrate how owning the put leg of the calendar strangle can help reduce the cost of the long call. Typically, when hedging through purchasing an out of the money call option on VIX to gain protection against tail risk there can be an undesirable carrying cost for the position. In periods of low volatility the long put position will benefit from the term structure of VIX futures pricing as the time to expiration for the option approached expiration. The long call position will be in place to potentially benefit from market conditions that result high higher implied volatility for the market as indicated by VIX.
The longer the market remains in a low volatility environment the more volatility traders are looking for ways to gain tail risk in an inexpensive way. The BofA Merrill Lynch VIX Calendar Strangle Index takes an innovative method of gaining inexpensive portfolio protection and demonstrates the performance in an index.