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HOW TO TRADE THE VIX: OPTION STRATEGIES AND HISTORICAL TRENDS

 * May 2, 2022
 * Market Rebellion

Market Rebellionmarketsoptionsoptions tradingstockstradingVIX


Many call the VIX the “fear gauge” of the market, believing it to be a measure
of investor sentiment at the given time. But what is that really accurate? What
do the readings of the VIX really mean? And how can you use the VIX to power-up
your trades? 


WHAT THE VIX ACTUALLY REPRESENTS

The VIX, or the CBOE Volatility Index, represents the expected size of upcoming
price-moves in the S&P 500 over a 30-day period. Calling it a fear gauge is a
bit of a misrepresentation, as it doesn’t actually represent emotions at all —
it’s a simple calculation with a specific meaning. 

Investors seeking a more pure representation of the market’s “fear” should look
to CNN’s Fear and Greed Index. This index takes into account more relevant
factors, like S&P momentum (against its 125 day moving average), a 5-day average
of the put/call ratio, stock price strength and more. 



Source: CNN


HOW THE VIX IS CALCULATED



Market Rebellion’s Head of Options Education Bill Johnson lays it out succinctly
in this video. To make a back-of-the-napkin estimate of the expected move in the
S&P according to the VIX, you can simply divide it by 16. VIX of 32? That’s a 2%
move in the S&P every single day, for 30 days. VIX of 16? That’s a 1% move in
the S&P. Every. Single. Day. And on it goes. 

Now, let’s look at a chart of the VIX to determine historical trends, how
traders could have profited in the past, and what lessons we can take into
future trading. 


THE VIX: MAX VIEW (MONTHLY CLOSE)

The CBOE VIX offers data tracing all the way back to January, 1990. That means
we have more than 32 years of data to pull from! During that time, the VIX has
only traded under $10 one time. In contrast, the VIX has risen above $32 just 11
times — that includes today, with the VIX currently trading at $34.96! Notably,
all of those surges in excess of $32 were short-lived relative to the overall
period that the VIX has been tracked! 

As Bill Johnson states in the video above, many skilled traders start to prepare
for downside in the VIX around levels like these. And he isn’t alone!



> “At a 16 VIX, that means the S&P has to move 1% per day — every single day.
> And so, is that happening? And then you get to 32. Okay, well now you gotta
> move 2% — every single day. […] When we see that implied volatility get up
> there […] that’s when you can pounce.”

This is not advice on where and when to short the VIX. Only an invite to think
about Pete’s question. Ask yourself, with a VIX of $34.96 (where we sit
currently) and a corresponding daily move in the S&P of 2.185%, do you think
that’s sustainable? 

Whether you do or not, you have a few options.


OPTIONS STRATEGIES TO TRADE THE VIX

Because the VIX is priced on a monthly interval, trading options on the VIX
directly can be a tough move to pull off, reserved for only the most advanced
option traders. But for those brave enough to try, it can prove incredibly
rewarding. For instance, we alerted Market Rebellion members to unusual options
activity in the form of VIX calls about one month ago.



This trader spent roughly $6.4 million dollars ($5.27-$5.28 per contract) on a
bet that the VIX (which was trading at just $20.29) would soar above $24 by
July. Those contracts are now worth $8.60 each, meaning the value of this
trader’s total purchase now rests at $10,430,940. In short: this trader made
more than $4 million dollars, a 63% gain! 

Conversely, this trader made an opposing VIX trade in the midst of the Covid-19
crash using put options. 



This bearish put spread was purchased with the VIX trading at $43.34 — a price
that it never returned to! By August 5th, the VIX was already trading under the
lowest leg of the spread, offering this trader a highly profitable exit from
their trade. 


OTHER WAYS TO TRADE THE VIX

Traders who want to take a different approach might consider using $SPY as an
inverse way to play the VIX. 



The inverse correlation isn’t perfect, but it’s pretty close! When $SPY makes a
big move, you can make a pretty safe assumption that the VIX is about to make a
contrarian move. 

One thing to consider: As the VIX moves higher, so too will the extrinsic value
of many option contracts. Extrinsic value is a fancy term for pricing-in the
potential move of an option by expiration. Stocks that are about to report
earnings, for example, are going to price in a lot of extrinsic value.
Conversely, when the VIX falls, option traders might be caught off guard by
diminishing extrinsic value in their contracts! 

One way to mitigate this is to use vertical spreads. Vertical spreads offset the
price you pay for an option by selling another option against it. If you believe
the VIX is about to decline, you might consider using a negative-vega strategy
like the credit spread! Negative-vega means a strategy benefits from a fall in
volatility! 

Likewise, if you think that volatility is about to soar, you might consider a
debit spread, or even a simple long option like a put or a call! These are
positive-vega strategies — meaning that they benefit from rising volatility!


THE BOTTOM LINE

By now, you should understand that there are a number of ways you could use the
VIX to power-up your trading. You can read into the calculation, using the vital
information it offers to make direct judgments against the potential daily move
in the S&P. Or you can measure the VIX against itself historically, using trends
or technical analysis to determine what is and isn’t likely based on past data.
You can even use the VIX to influence your positioning elsewhere in the market!

And perhaps most important, you can use options to tie it all together. Whether
you believe the VIX is heading up or down, options present traders with a vast
arsenal of powerful weapons that they can use to exploit the move. No matter how
you choose to play the VIX, the most important thing is that you’re aware of it!
If you understand the data it’s providing, and you’re capable of using a variety
of option strategies, you can use the VIX to your advantage. Want to learn more
about the option strategies you can use to benefit off the back of big VIX
moves? Check out Market Rebellion’s free Professional Options Trading Guide!


MARKET REBELLION




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