We like to sell option premium in high Implied Volatility (IV) environments, especially if IV rank (IVR) is also high. We do this because IV is a mean-reverting metric. When IV is low we may look to buy premium using low IV strategies or to get long the VIX. Since we also strongly believe in cost basis reduction a Covered Call would seem to be our best strategy, especially as the low IV environment might last a while before reverting to the mean. There is no direct underlying for the VIX so how do we create a Covered Call?
We can create a Covered Call by buying the VIX futures (/VX) and selling 10 of the at-the- money (ATM) VIX calls. The problem is that although our studies show it is profitable it can be expensive and tie up a lot of capital. Many traders can’t afford that especially tastyBITE sized accounts. Is there an alternative using the VIX options? We can create a Synthetic Long Position by buying an ATM call and then selling one VIX ATM put. It’s important to note that the VIX options are priced off the corresponding month /VX future. The July /VX future has 29 days to expiration (DTE) and the July VIX options have 28 such days. Your cost basis will be essentially the same. So how does the synthetic strategy compare to the full sized one?
Our study was conducted using the /VX futures and VIX options from June 2008 to 2015. At VIX settlement, if /VX was below 15 we bought one synthetic long VIX in the option cycle closest to 30 DTE. We sold the first OTM call against it. As a reminder why we prefer Covered Calls to the outright underlyings we also provided results for our long synthetic position by itself. It underperformed the VIX Covered Call. Our overall position though, of the long synthetic underlying and the short call against it equaled the larger one with everything lowed by a factor of ten (of course POP remained the same at 63%). The average P/L was a tenth but so was the margin.
For more on /VX and the VIX see:
Market Measures from September 4th, 2015: “Expectations | VIX Products”
Market Measures from October 29th, 2015: “Buying Low Vol | /VX Covered Calls”
tasty BITES from November 3rd, 2015: “How to Trade VIX Futures Small”
Watch this segment of tasty BITES with Tom Sosnoff and Tony Battista for the valuable takeaways, a better understanding of Covered Calls and a way to use Covered Calls in the VIX without tying up a lot of capital.
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