Event Trading with VIX Put Options
I have created trading rules using VIX as a method for high returns in a short period and relatively safe. It seemed quite good when I tried it in October, so I'm summarizing it in this article. It can be said to be a beginner-friendly method as it's mentally gentle.
Note that you need to understand options, so if you're not very familiar with them, please read this while researching. Also, you need a U.S. securities account such as Interactive Brokers for trading.
What is VIX
VIX is a somewhat special index, and colloquially, it can be said that the instability perceived by market participants becomes the value. More accurately, I believe it was "the annual volatility of the S&P 500 derived from the options market expected for the next 30 days," but I'll omit that as it's not relevant this time.
Now, VIX has the characteristic of being consistently low most of the time. In recent times, it would be normal business below 20. And when U.S. stocks plummet, it jumps up and then comes back after a while. In a market that seems like the end of the world, it sometimes exceeds 40 and doesn't come back for a while. It also rises with sharp rises, but not as much as with sharp falls. I don't know if it's reflecting public opinion or because it's a volatility rate... I'd like to investigate someday.
VIX 1 year
VIX 5 years
(Images from Yahoo Finance: https://finance.yahoo.com/quote/^VIX/)
By the way, it's common for the VIX price to move 10% in a day. If a big crash occurs and it goes from 20 -> 30, that's a 150% change. There's no concept of limit down, so it can move as much as possible.
Trading Methods Using VIX
Looking at such a graph, you might think of the following strategies:
- Buy when it's low, sell when it goes up
- Sell when it's high, buy back when it goes down
However, 1 is not recommended, and 2 is quite tricky if traded normally.
Problems with the "Buy Low, Sell High" Method
First, VIX is an index without substance, so you can't hold and keep it. When trading, it's futures, so rollover costs always occur. Since you don't know when it will go up, you end up paying costs continuously. Moreover, there's the hassle of rolling over every month.
Also, when holding for a long time, that capital is tied up. In the midst of high U.S. dollar interest rates, it's painful to keep waiting with capital in futures.
"Sell High, Buy Back Low" Method
On the other hand, this has the advantage that the timing of decline is relatively easy to predict. Unless the market collapses, it usually returns to its original level somewhere within a week.
However, if you consider selling futures and making sufficient profit, there's always the danger of stop-loss. Even if you sell at 20 and it becomes 15 a month later, if it becomes 30 in between, there's a high possibility that your funds will short. And looking at past examples, it wouldn't be strange even if it becomes 40. Even worse, it often moves a lot during non-trading hours, so even if you set a stop order, it often executes far away.
For example, if you sell 1 contract (1000 units), you need 20*1000=20K (actually less due to margin trading). If the VIX price becomes -5, you gain 5K and hooray, but if it becomes +10, it's -10K. In this example, if you didn't prepare 1.5 times the capital of the position you want to take (30K), you were out.
Method Using Put Options
That's why options are for times like these. By buying Puts, we'll try to gain safety in exchange for paying an insurance premium.
The specific rules are as follows:
- Look at option prices when VIX exceeds 25
- Buy when the expiration date is more than 1 month and the breakeven point for purchasing Put options is 20.0 or higher
- Decide the profit-taking value at the beginning
- Exit at breakeven or take profit 1 week before expiration
- Cut losses sometime 1 week before expiration
Simple, isn't it?
Example
When VIX exceeded 25, I searched for VIX options. I found a 26 PUT for $6.0 with 33 days to expiration, so I bought 10 units. I set it to take profit when VIX reaches 15 and went to sleep.
(1) 20 days later, VIX reached 15, so I settled. Being Deep ITM, the time value had decayed and the profit was almost 5 * 1000 = 5K.
(2) 20 days later, VIX became 22. Being ATM, time value was added and I could exit at breakeven.
Advantages
The biggest advantage is that losses are limited. Naturally, there won't be any loss beyond the premium paid initially. This makes fund management easier and helps in taking positions within one's means.
Next, it has a beginner-friendly specification where retreat is easy. If VIX approaches the strike price near the expiration date, the option you hold becomes ITM, and due to the addition of time value, losses are suppressed. It's very easy to exit at breakeven, which gives peace of mind.
Lastly, it's good that profit margins are easy to understand. It's easy to decide "I'll take profit when VIX becomes 15" at the time of purchase, so you can know both the final profit and the worst-case loss, allowing for trades considering the risk-reward ratio.
Regarding the thinness of the order book, which is a concern in option trading, VIX has an unusually thick order book, perhaps due to arbitrage or market-making bots. The spread is likely to be 0.1 (minimum unit) for most of the time.
Disadvantages
While there are such advantages, there are naturally disadvantages.
Above all, the premiums are high. High VIX means high IV, so inevitably you end up paying high premiums. Also, to increase safety, a certain number of days is necessary, so time value is added. These double whammy reduce the expected value.
And above all, the problem is that opportunities are limited. It's a rule that might happen once a year... so you can't rely on this income to make a living.
Summary
I created rules for purchasing VIX Put options to conduct trades with high safety and profitability. Although opportunities are very few, it might be worth considering as it creates profit opportunities in a sharp decline market with short-term capital commitment.
