1. Trading the volatility ETPs
The Option Pit Method
Trading the volatility ETPs
Option Pit

2. Trading the Volatility ETP’s
What we will cover:
Intro and Trail of the VIX
Learning VIX zones: an Option Pit Exclusive
Pricing Volatility ETP’s
VXX/UVXY/XIV
SPY and VXX trading
Trade Structures
Trades for Monday

3. Trading the Volatility ETP’s
The goal of our short course is a method for evaluating the Volatility ETP’s
We will take into account realized volatility, time decay, VIX and VIX futures levels for VXX/UVXY/XIV/SPY/
This is not easy, but it can be if we think about it right

4. options Trail of the VIX
The first thing to remember about the Volatility ETP’s options is that they are:
options
on an ETP
From VIX futures
on the VIX index
from option volatility
on a cash index……... Aaaaahhhhhhh
That try to predict forward volatility

5. Trail of the VIX VIX ETPs’ VIX Options VIX ETP Options VIX Index
S&P 500 Index
S&P 500 options
S&P 500 Index Volatility
VIX Index
VIX
Futures
VIX ETPs’
VIX Options
VIX ETP
Options
Trade!

6. Understand the VIX first!
The Trail of the VIX tells us we need to understand how the VIX works before we trade the Volatility ETP options.

7. Trail of the VIX
The understanding comes from the unique character of VIX movement.
The Option Pit secret is to think of VIX in Zones!
Implied Volatility does not go up forever!

8. Pricing out the VIX Zones

9. Pricing out the VIX Zones

10. Pricing out the VIX Zones
The idea of VIX zones helps quantify the trades from a reverting frame of reference
For instance: A Zone 1 trade has small downside since VIX does not trade below 10 but could have giant upside potential
We create Volatility ETP trades based on the Zone

11. Don’t forget realized volatility- Volatility Gravity!

12. How the VIX trades

13. Trading the Volatility ETPs
The most important thing to remember is that Volatility ETP’s are decaying
assets and decay at different rates depending on the level of Contango
But
They have a floor!

14. VXX/UVXY
The VXX or the iPath S&P 500 short term futures ETN attempts to replicate being long VIX futures with a constant duration of 30 days
The UVXY seeks to double the performance of the VIX near term futures
As you will see from the chart there is considerable slippage in the product

15. VXX/UVXY

16. VXX/UVXY
Note that the VXX and UVXY decay on a daily basis because of Contango

17. Setting up strategy and time frame for Volatility ETPs
The investment decisions are based on time frame:
Longer Term of a 1 year duration: looking at ownership
Delta and Vega position- managing the direction by Vega
Shorter Term of a month or less: This is a trade looking to unwind
Gamma and Vega position- managing the direction by Gamma
This is so the average investor can be short term wrong but long term right.

18. Why Buy Options?
Fallacy of buying options- you can never make money buying options
If the market is moving faster than the implied volatilities are priced, option buying is almost always preferable.
Why? The options are pricing a
standard deviation move less than
the market is actually moving.

19. VXX/UVXY Note the way the volatility products trade:
The are long term crappy because of the roll yield issue
But
Short term they can have powerful moves up AND limited moves down (can’t go to 0 in 1 day)
So between VIX Zones and Term we can determine useful ways to trade VXX/UVXY

20. Putting VXX/UVXY trade together
What our the current conditions:
VIX is in Zone 2 possibly on its way to Zone 1
In Zone 1 the downward path starts to slow down since the VIX is near the bottom
We could buy longer term OTM puts or
Create trades to sell shorter term OTM puts (1 x 2 ratio trades or broken wing butterflies)

21. VXX broken wing fly for Zone 1 & 2

22. A long term play is not a bad way to trade the decay
Roll Decay for 1.5 years
468 days at .07 per day is which is below which puts VXX below 0
The problems are VIX can rise, futures can go into contango, no weekend decay but still
A long term play is not a bad way to trade the decay

23. Long Term Puts

24. XIV
XIV is an inverse VXX
What Zone does XIV become interesting?

25. XIV A nice trade in a higher VIX Zone Fits in an IRA
Shorting Volatility with no option decay
When falling from one zone to another
The Pitfalls are it can delist on a giant spike in volatility so protect or wait until VIX is already
dropping

26. VXX/UVXY Buying puts in VXX/UVXY is normally the best play if
VIX is crossing from a higher Zone to a lower Zone
Realized Volatility in the SPX has been high and is starting to drop
There is heavy contango in the future products
All three conditions are optimal!

27. Advanced VXX- up Zone
Because of VXX skew, upside butterflies are very cheap

28. Short Duration Positions SPY/VXX
Time to step in this week and get long?
You could be right you could be wrong!
What do we know?
The market is moving
The implied volatility is moving up
with it
The position is to own Gamma and at a minimum
Be flat Vega- This is easy to test

29. Back to the Future Oct 3, 2011

30. Back to the Future Oct 3, 2011
The price of 10 SPY Nov 109 straddle was
The price of 3 VXX Nov 57 Put was 7.25
The vega on the straddle was 155
The delta on the VXX puts was -131

31. Back to the Future Nov 3, 2011
The value of 10 SPY Nov 109 straddle was up around $4700.
The value of the 3 VXX puts was up $2300
The vega on the straddle was 25
The delta on the VXX puts was -285

32. Executing the Vega Neutral Straddle
Why does this work? The volatility products follow the path of IV.
When IV jumps, they jump. This allows Vega to be “neutralized” but have a positive curve

33. October 3rd, 2011 and Now
VIX can get much more
Backward than today

34. Executing the Vega Neutral Straddle
First identify the market and capital allocation
Try to keep the delta of the Volatility product part equal to the Vega of the long gamma part
If IV screams, this position will get long more Vega
There is almost no negative theta when IV jumps
The ideal close is when the one part pays for the other, then unwind the profitable part.

35. Market Conditions for the Vega Neutral Straddle
Where can the straddle go?
Where is realized volatility?
Where can VXX go?
Where is VIX and the VIX futures?
What is the management routine?

36. VXX Put Profile

37. Today
Here is what this idea would look like today:

38. Wrapping up Understand the VIX acts differently Learn the VIX Cascade
Check for a VIX Zone
Pick the right ETP for the job
From the Zone, pick the strategy
Use SPY and VXX in Zone 3 and 4

39. Thanks for attending!
Mark will be on next with a special offer at the end! 1(888) Trade-01