by Tyler Craig | October 2, 2012 11:19 am
In mid-July with everyone’s favorite volatility ETN — iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX) — knocking on the door of single digits, I laid out the case for a reverse split (“Why VXX Should Reverse Split”). Though Barclays (NYSE:BCS) made us wait a bit longer than many had hoped, a little over a week ago it finally announced plans for a 1-for-4 reverse split, effective this Friday. Assuming VXX remains around $9, the reverse split should lift the share price to around $36.
But far from being a game-changer, the split merely extends VXX’s shelf life. Provided we don’t enter a 2008-like bear market, VXX should continue its inexorable grind lower. While occasional exogenous shocks to the market will lift volatility and thus VXX in the short run, the bearish endgame is all but assured.
One group applauding the reverse split is option traders, who are growing tired of the lack of out-of-the-money option contracts with adequate premium listed on VXX.
Let’s say you’re initiating some type of put spread involving selling a shorter-term out-of-the-money option. When VXX is trading at $36, the 35, 34, and maybe even 33 strike put options will command greater than 60 cents or so. This provides flexibility in deciding the optimal strike price to sell. But with poor ol’ VXX falling to the basement at $9, you have to go all the way out to December to sell an out-of-the-money put for greater than 60 cents.
(Of course, you could sell an Oct 8 put for 15 cents, but when commission is taken into consideration that doesn’t really amount to much.)
Click to EnlargeWith the S&P 500 Index still entrenched in an uptrend and VIX futures in steep contango, the outlook for VXX continues to be grim. While October could see a broad-market correction that may lift VXX a bit, I would use the opportunity to enter bearish plays on the volatility ETN. The bullish year-end seasonality of the stock market coupled with volatility’s well-established track record of drifting lower through the holidays should add to the bearish barrage on VXX.
Following the split, traders might consider entering December bear put spreads on VXX by buying a higher strike put and selling a lower strike put in the same expiration month. Assuming the post-split stock price is around $36, something like a Dec 37-32 put spread could be attractive for traders looking for softness in VXX.
At the time of writing, Tyler Craig had no positions in VXX.
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