A strategy we have discussed many times is a Covered Call. We like how it enables us to lower our cost basis. We have seen some recent stretches of low Implied Volatility (IV) has been low. Buying a Covered Call in the VIX would seem to be a good play since volatility is mean reverting. The problem is that the underlying on the VIX does not trade anywhere. We can adjust for that by creating a synthetic position in which we would sell an at-the-money (ATM) Put and buy an ATM Call. That runs into another problem since the options are based upon the VIX Futures price (/VX). We compensate for that by using the Put and Call strikes closest to a 50 Delta. How did the strategy perform?
Our study was conducted in the VIX using data from 2006 to the present. We chose the option expiration cycle closest to 45 Days To Expiration (DTE) and traded a synthetic Covered call comprised of a short 50 Delta Put, a long 50 Delta Call and a short Call 2 points above the long Call with a Delta in the 30-35 range. We then compared managing the trade at 25% of max profit (if possible), 50% of max profit (if possible) or held to expiration.
A table of the results was displayed. The table included the success rate, average P/L and average days in the trade. Although managing the trade boosted the success rate, it did not help the bottom line P/L by much. A second results table with the same metrics but entering trades when the /VX Future was below 20 was displayed. This helped our bottom line P/L and success rates but was only “a marginal trade.” A final results table entered trades only when the /VX was below 15. The table showed that the average P/L on the trades managed at 25% were actually lower but the trades that were managed at 50% had a higher P/L. Tom noted, “Statistically speaking, it’s just a marginal trade. If you're going to do it you have to wait until the /VX is below 15.”
For more information on the VIX & Synthetics see:
Closing the Gap from December 22nd, 2015: "Covered Strangle: Synthetic Underlying"
Strategies For Your IRA from December 23rd, 2015: "Shorting Stocks With Modified Synthetics"
Closing The Gap from May 16, 2016: "Covered Strangles: Synthetic Underlying Strike"
Market Measures from June 17, 2016: "Fading Fear | Trading After Large VIX Moves"
Market Measures from June 28, 2016: "Buyer Beware | VIX Call Calendars"
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the valuable takeaways and the results of our study on synthetic Covered Calls in the VIX as a possible trade to get long Volatility and how best to manage the trades.
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