Stubborn VIX Holding Back the Goodies

by Tyler Craig | June 9, 2011 6:16 am

Stubborn VIX Holding Back the Goodies

Short put spreads hold a well-deserved spot in my bag of tricks. While option trading[1] investors can use this play under a variety of market conditions, I’ve found it particularly potent when we have an oversold market coupled with a spike in the CBOE Volatility Index (CBOE: VIX[2]). The VIX closed yesterday at 18.79, up 0.72, a nice move of nearly 4%, but nothing spectacular.

Since the S&P 500 Index Options (CBOE: SPX[3]) is on both its sixth down week and sixth down day in a row it is certainly reaching oversold status. That leaves many to conclude some type of bounce may be in the offing. Unfortunately the second part of our money making combo hasn’t come to pass. As insightfully outlined in Adam Warner’s ”Low Volatility VIX in Midst of Sell Off[4],” the VIX has thus far stubbornly refused to spike. One group of traders who are likely finding the VIX’s recent behavior annoying is put spread sellers.

Why?

It’s robbing them of better premiums by keeping the value of out-of-the-money puts depressed. Put simply, without a spike in the VIX, the market’s Fear Gauge, traders are holding off bidding up the premium in options in related indexes like the SPX and everybody’s favorite, the SPDR S&P 500 (NYSE: SPY[5]).

SPY closed today at $128.42 so I was considering selling the SPY Jul 124 – Jul 119 Put Spread as a short term play to profit from some type of bounce in the market. That is, sell the SPY Jul 124 Put and buy the SPY Jul 119 Put. At current volatility levels the spread is valued around $0.86. Not too shabby, but were volatility elevated a mere 3 points higher the spread value would be around $1.00. While a $0.14 difference doesn’t seem all that monumental, it does increase the potential return by almost 5%.

As I see it traders looking for put spread selling opportunities in the coming days have two choices.  You can accept that the VIX spike may not come to pass during the current market downswing and sell put spreads anyway. Or, just avoid the coming bounce play altogether — unless or until we see enough panicked selling to kick the VIX higher.

At the time of this writing Tyler Craig had no positions in the names mentioned.

Endnotes:
  1. option trading: http://investorplace.com/options-trading/
  2. VIX: http://studio-5.financialcontent.com/investplace/quote?Symbol=VIX
  3. SPX: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPX
  4. Low Volatility VIX in Midst of Sell Off: http://investorplace.com/44585/low-volatility-vix-spx-sell-off-qid-sds/
  5. SPY: http://studio-5.financialcontent.com/investplace/quote?Symbol=SPY

Source URL: http://investorplace.com/2011/06/vix-spx-spy-option-premium-put-spread/
Short URL: http://invstplc.com/1fzTDuE