by Gavin in Blog, implied volatility, Options Trading Strategies, Trading Volatility
November 6, 2018•5 comments
This VXX trading strategy is very easy to implement. Read on to learn more, but first let’s look at what vxx actually is.
VXX Explained
VXX is an Exchange Traded Note (ETN) available for trading on the US markets. It is a volatility based product that expires in January 2019, although the issuer, Barclays Bank PLC, has recently created a second Fund VXXB which is identical.
VXX can be bought and sold just like any stock, but it is not a stock and does not behave like one. Some traders think VXX tracks the VIX Index, but in fact it is based on VIX futures which is entirely different.
You can read a detailed explanation of the product here.
If you look at a long-term chart of VXX you will notice that it has relentlessly moved lower over time with occasional spikes. This is because of the constant decay due to the way it is calculated and the fact that most of the time, markets are in Contango.
Watch the short video below to learn more about Contango and Backwardation.
It seems like a bit of a no brainer trade to just short this thing, right? Well, not really. There have been some pretty massive spikes along the way, so you would definitely not want to short the product or sell naked call.
VXX Trading Strategy
However, buying put options tends to work quite well if you can get the timing right on a nice vol spike. Using puts spreads helps to keep the cost down and I like to go quite far out in time to give the trade plenty of time to work out.
One major variable is that we don’t know when the bull trend has ended and a vol spike, and subsequent rise in VXX could end up lasting a long time.
During the 2008-2009 bear market, it took VXX well over a year to drop back to pre-crisis levels.
Here are a couple of trading rules I like to follow:
- Go far out in time, usually that means at least 4-5 months for me. This gives the trade plenty of time to work out.
- Wait until the VIX Futures Curve heads back in to Contango. I may not get the absolute top of the vol spike, but I feel my odds are improved by doing this.
- Takes profits systematically as the trade moves in your favor.
A great resource for checking the state of the VIX Futures Curve is http://vixcentral.com/
This trade has worked very well over the last few years, BUT if we do enter a bear market, it might be time to put this one on the shelf for a few months.
Good luck out there traders.
Gav.
Disclaimer:The information aboveis foreducational purposes onlyand should not be treated as investment advice.The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
5 Comments
BajaPete says:September 15, 2020 at 3:18 am
I’m confused by your article. It says when the Vix futures market heads into Contango (meaning volatility is dropping) to buy Puts on VXX 4 months out in time to play a spike in VXX. Shouldn’t this trade be buying Calls instead of Puts?
Reply
- Gavin says:
September 15, 2020 at 9:15 am
You want to buy VXX puts when it spike up because it almost always drops back down within a few months. So in mid-March 2020 when VXX was at 80, you buy some September puts which are now be well and truly in-the-money.
Reply
- Felix says:
October 11, 2020 at 2:38 pm
Hi Gavin,
Thank you for this.
1) What’s a good Long Put strike if the VXX spikes to say 80? In the recent months, it only had spiked to say 28-35. Say 23? or if Based on Delta, perhaps 16-25 Delta OTM?
When the VXX/UVXY ETN products drop in price, does the underlying IV increase or decrease?
2) I have +23p, +24p LEAPS April 2021 (180days+) to amortize the theta decay in order to eventually sell Puts (PMCP or Diagonal Put Spreads). What’s the downside of picking Long-dated Puts as oppose to 3-4 months (not as capital efficient?)?
I think if it spikes up, it declines pretty fast that it wouldn’t make sense to sell OTM Puts (PMCP, Diagonal Put Spreads), and if yes, would need to sell farther out of money (3-4 weeks and OTM)
Thoughts?
Felix
Reply
- Gavin says:
October 12, 2020 at 11:56 am
1) Based on delta is a good guide, that way it will be consistent no matter what the underlying spike to and yes 15-20 delta would be good. Or you could go deep in-the-money in order to pay less time premium.
2) Yes long-dated puts will tie up more capital, but also gives you more time to be right. 180days+ seems ok though.
Reply
- Edgar says:
April 28, 2022 at 2:16 pm
Hello Gavin.
Three questions.
1. Why we should avoid this strategy in bears market If its the time the VIX usually spikes?
2. What happen If you get short selling calls (naked or spread?
3. What do you think about SVXY? Could work similary like this..
Reply
BajaPete 
Felix 
Edgar Leave a Reply
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