A recent Volatility put spread may indicate a way to exploit recent moves in the VIX.
For a brief period, prior to both last week’s Fed meeting and the jobs report, it seemed like volatility was returning to the market. The Cboe Volatility Index (VIX), the most popular measure of market volatility, climbed from about 13 to 15 possibly in anticipation of surprising news.
The Federal Open Markets Committee (FOMC) meeting did cause a bit of uncertainty, but it was quickly put to rest by a far better than expected jobs number. There are big players who support a rate cut, some who are pushing for a rate increase, and others who are happy with where we stand. The jobs numbers currently supports the status quo, which is the least likely to cause additional volatility. By the end of the day Friday, the VIX was back under 13. All, it seemed, was calm.
As we approach the summer, the crowd will almost certainly be expecting smooth sailing until roughly the next school year. The summer is traditionally a slow period for the markets. Once earnings season is done with, there won’t be a whole lot for the market to worry about for several weeks.
The only action may come from this week’s CPI and PPI numbers. Investors are certainly paying close attention to anything inflation related for clues on when the Fed may raise/lower interest rates. There’s also a small possibility of a China trade deal, or lack thereof, which may provide a spark. Generally speaking though, it wouldn’t be a shock to see a very calm and boring summer.
That being said, how do you trade such a situation? One trade I spotted last week takes on this challenge.
A trader, looking ahead to the June 21 expiration, purchased 4,000 put spreads in ProShares Ultra VIX Short-term Futures ETF (UVXY). First off, UVXY tracks the first two VIX futures contracts, or what we refer to as short-term volatility. UVXY is leveraged, but only 1.5x, so it moves 50% more than a standard non-leveraged ETF.
Back to the June put spread. The trader bought the 30 puts and sold 25 puts at the same time with UVXY trading at just under $31.50. The total premium cost of the trade was $2.30, which places the breakeven point at $27.70. Max risk is the number of contracts multiplied by the premium, or about $920,000 in this case.
Max gain on the put spread is $2.70, which occurs if UVXY is at or below $25 by June expiration. In that scenario, the buyer would generate a little more than $1 million in profit. From a return perspective, that would be a 117% gain.
UVXY tracks short-term volatility, so a put spread comes into play if volatility retreats. UVXY will move down as VIX decreases. Even if the VIX stays stagnant, UVXY will drop over time due to the futures roll (a common issue with long futures type products).
In other words, barring some unexpected news, this put spread is in pretty good shape to pay off. As you can see from the chart, UVXY moving down over time is the normal scenario for this instrument.
What’s more, it’s an easily replicable trade. You can buy this exact put spread or something very similar in your own account. As a debit put spread, all you need is the premium money in your account to make the trade.
Tuesday rise in volatility makes this a more attractive trade.