The title of this blog refers to three parts and this is because we just had the third trade in the ongoing saga of a large 1 x 2 call spread in VIX options come into the VIX option pit yesterday. There is actually another piece to the puzzle as when the first trade was initiated part of the transaction involved a large sale of call options and that position may still be open. I do my best to keep blogs short, but I’m going to run through all three transactions individually and this cannot be done in a 500 word space.
The specific size for the legs of these trades is about 181,000 for the 17 Strike Calls, 84,000 for the 20 Strike Calls (June only), and 362,000 for the 23 Strike Calls. I know this doesn’t break down exactly, but I think it is easier to look at this trade as starting out long 2 VIX Jun 17 Calls, short 1 VIX Jun 20 Call, and short 4 VIX Jun 23 Calls so I’m going to show the trades like this in the examples below.
Also, each payoff diagram highlights where VIX closed and the VIX futures that match up with the open option position settled at the end of each day.
Part 1 – April 10th
Back in April, 2 VIX Jun 17 Calls were purchased for 1.74, 1 VIX Jun 20 Call was sold at 1.10 and 4 VIX Jun 23 Calls were sold at 0.82 each. A payout diagram with the assumption the trade was going to be held to June expiration is below. We know parts of the trade have been rolled, but taking a look at the payout diagram always gives us a good picture of a trade’s risk and potential reward. As a side note the VIX Jun 20 Calls were offered at 0.10 (a 1.00 gain on that position) as I was writing this blog.
If there had been no changes to the trade and we think of this as a 2 x 1 x 4 spread that was initiated for a credit of 0.90 then June VIX settlement under 17.00 would result in a 0.90 profit. The best case scenario would be VIX at 23.00 where a profit of 9.90 would be realized. However, we know the 17’s and 23’s were rolled two times now so this is really an academic exercise.
From this point what I actually want to do is separate the rolled positions from the short June 20 Call. I know in the ‘real world’ the whole portfolio should come into play and consideration, but my goal in these blogs is more educational. Also the June 20 Calls expire in just a few days and as long as VIX is under 20.00 the result will be a profit of 1.10 on that individual position.
As a 1 x 2 ratio spread, the initial trades would be a buy of 1 VIX Jun 17 Call at 1.74 and selling two VIX Jun 23 Calls at 0.82 each (1.64) for a net debit of 0.10. For the next two parts of this blog we’ll just focus on the ratio spread.
Part 2 – May 11th
All VIX observers are pretty sure the May 11th roll was the biggest trade up to that point in time in the history of VIX option trading. That trade also resulted in May 11th being the biggest volume day in the VIX pit this year. Going into the day the firm behind this trade was long 1 VIX Jun 17 Call for every 2 VIX Jun 23 Calls they were short. Recall that this position was initiated at a cost of 0.10.
The June rolling trades involved selling the VIX Jun 17 Calls at 1.23 and then buying back the VIX Jun 23 Calls at 0.50 each. This would result in a credit of 0.23 per spread on the June side of the roll. The trader then purchased 1 VIX Jul 17 Call at 1.89 and sold 2 VIX Jul 23 Calls at 0.90 each for a net cost of 0.09 on the July leg of the roll. The net credit on the roll comes to 0.14 which if combined with the original cost in April of 0.10 gets us to a net running credit of 0.04 on the ratio spread.
The payout for being long 1 VIX Jul 17 Call and short 2 VIX Jul 23 Calls at a credit of 0.04 appears below –
Note the break-even level is just over 29.00 so there is quite a margin of safety for this trade after netting a small credit through the rolling transaction. Do keep in mind that the line on the right side of the diagram can keep going lower so a volatility environment like 2008 – 2009 could result in substantial losses.
Part 3 – June 10th
So yesterday this trade was rolled for the second time and the result was the biggest VIX option volume for 2015, passing the high mark on May 11th.
The VIX July 17 Call was sold at 1.19 while the VIX Jul 23 Calls were purchased for 0.50 each. The net result was a loss of 0.70 for the long VIX July 17 Call leg, but a gain of 0.80 per spread (0.40 x 2) on the short VIX July 23 Calls for a net gain of 0.10 per spread. Some of this gain was given up as the August trades involved buying 1 VIX Aug 17 Call at 1.75 and selling 2 VIX Aug 23 Calls at 0.85 each (1.70) for a net cost of 0.05. The result for this rolling transaction was a credit of 0.05 which combined with the 0.04 credit that was in place as of May 11th gives the ratio part of this trade a running credit of 0.09 and a payoff at August expiration that is represented by the diagram below –
So the ratio spread keeps on being pushed out to the third month when we get close to expiration on the front month. It will be interesting to see if any sort of rally in VIX prompts a different managing action. Also, if VIX continues at current levels, in the low teens, will we see a roll to September? Either way I’m keeping an eye on the VIX Aug 17 Calls and VIX Aug 23 Calls until this trader makes his next move. When he does we’ll be sure to update everyone in this space.