The Week in VIX – 6/22 – 6/26

VIX was up slightly last week, but the futures took their own path and were lower across the board. The July premium went from about 1.50 to 0.50 relative to spot VIX which is a bit surprising since we have the monthly employment report coming on Thursday before we all enjoy the birth of our country with a long weekend.

VIX Curve - Table

I came across a usual spread trade on Friday, at least unusual at first glance. There was a seller of VIX Jul 18 Calls at 0.61 who purchased VIX Jul 21 Calls at 0.40 for a net credit of 0.21. Selling a call spread is a pretty simple trade, but there were not done yet. There were two other legs to this trade, a purchase of VIX Sep 18 Calls at 1.55 and sale of VIX Sep 21 Calls at 1.10 for a cost of 0.45. Putting these two trades together I get a net cost of 0.24. I also started thinking about the ‘why’ behind the trade with my guess to follow.

I think it is apparent that if VIX is under 18.00 at July settlement and over 21.00 at September settlement we have a best case scenario if there is not managing around this trade. Basically calm volatility for the next few weeks followed by an increase in volatility going into the fourth quarter.   However, I think there may be a bit more to this trade.

First, the August expiration was skipped which makes me think another credit spread using call options is on the horizon, possibly to be put on after July expiration, or if the market moves up, maybe even before then. VIX options are often considered expensive for many reasons and selling the near term call spreads to help pay for the longer dated spread does make some sense.  Especially if the expectation if VIX to remain at low levels in the near term.

That leads to my other thought which relates to calendar or diagonal spreads. Since VIX options with different expiration dates have different underlying values with which to value them, calendar spreads are often avoided due to risk concerns.  The risk being the same for this combination of short and long call spreads, in this case that July VIX experiences a spike and September hardly moves.  What is different is that the potential loss behind this trade is known since it is constructed using vertical spreads instead of one short call versus a longer dated long call. The same mentality that is uses for a calendar spread may just be behind this trade.

Either way, this is one I’m keeping a close eye on and will also be on the outlook for a similar sized August spread trade on any move higher in VIX or after July VIX options settle on the 22nd of next month.