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Why VXX Should Reverse Split

The lower it goes, the harder it is to craft a good option spread


The iPath S&P 500 VIX Short-Term Futures ETN (NYSE:VXX) burst onto the volatility scene at a cool $100 (split-adjusted) on January 30, 2009. With the equities market grappling with a hangover from 2008’s malaise, VXX was able to withstand the beckoning of lower prices for a little over two months.

Then the epic slide commenced.

Fast forward 1 year, 9 months, and 10 days: With poor old VXX staring single digits in the face, issuer Barclays (NYSE:BCS) implemented a 1-for-4 reverse split on November 9, 2010, to lift the beleaguered ETN back above $45. Interestingly, it announced the reverse split a few weeks prior, when VXX was trading around $12.68.

And hey, VXX has survived another 1 year, 8 months, and 9 days without needing another reverse split. Given that this go-around VXX started dropping from $45 instead of $100, it’s fair to say its post-split performance has been notably better than its pre-split performance.

But with VXX closing on Tuesday at $12.70, it’s eerily close to the threshold it reached just before its reverse split in 2009. Though Barclay’s white horse of reverse split salvation has yet to appear on the volatility horizon, that doesn’t mean it’s not getting prepped in the stables.

Of course, a reverse split would be a welcome development for the everyday option trader — particularly for those employing spread strategies. Anytime a stock approaches the single digits, it becomes increasingly difficult to structure worthwhile spread positions due to the following two reasons:

1. Even with $1 dollar wide strike prices, a move from one strike to the next represents a 10+% change. This severely limits the amount of option strikes that have enough premium to be considered “in-play,” thereby increasing the difficulty of structuring a position that’s worthwhile.

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2. Given the cheapness of options on low-price stocks, traders may be forced to initiate positions with a large amount of contracts, which increases commission costs. For example, with VXX at $50, I may be able to initiate one $5 vertical spread for $300. If VXX is at $11, I may have to initiate upwards of five $2 vertical spreads for the same $300.

That’s a 10 contract trade versus a 2 contract trade. Depending on your broker that could make a huge difference in transaction costs.

So, here’s to hoping Barclays sallies forth from its citadel to save VXX yet again from entering the underworld of single digits.

At the time of writing Tyler Craig had no positions on VXX.

Article printed from InvestorPlace Media,

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