Trade SPX Options Amid an Overblown VIX

by Tyler Craig | December 4, 2013 8:31 am

Don’t look now, but fear is making a comeback. Amid the three-day stock slide, Wall Street’s favorite volatility gauge — the CBOE Volatility Index (VIX[1]) — rallied more than 15% to a new two-month high. With the S&P 500 down a mere 1%, the outsized jump in the VIX seems pretty overdone, no?

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Of course, you won’t hear any option sellers complaining. Volatility jumps re-inflate depressed option premiums, increasing the potential profits (and thus allure) for all sorts of option-selling strategies — naked puts, credit spreads, condors, you name it.

Adding further appeal to exploiting the sharp uptick in volatility is the technical posture of the market. Remember: The VIX and S&P 500 tend to have a negative correlation — when one zigs, the other zags. Saying that the VIX is unlikely to go much higher from here is similar to saying the S&P 500 is unlikely to go much lower.

And, indeed, that seems to be the case. The SPX remains above all major moving averages with support levels aplenty looming closely. While the current pullback might extend itself a fourth or fifth day, this dip is much more likely to get bought than morph into a nasty correction.

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Yet another reason the VIX should remain subdued is the utter lack of volatility in stock land. For all its fury, this week’s market downturn did little to lift realized volatility, which has been stuck at 9% for a month now.

Unless the market really start movin’ and groovin’ a VIX of 15% is simply too high.

To exploit potentially overpriced options as well as position yourself to profit from a resumption of the bull market, you could sell the SPX Jan 1725-1715 put spread for $2 credit. Consider it a bet that the SPX remains above 1725 over the next month.

The max reward is limited to the initial $2, and the max risk is limited to the distance between strikes minus the net credit, or $8.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. VIX:

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