EQD Research: European Volatility Traders Looking Beyond U.S. Election

In late October something interesting happened with respect to the open interest for VSTOXX futures. Specifically, the open interest for December futures surpassed November open interest with fifteen trading days remaining to November expiration. This shifting of open positions is typical as an expiration date approaches, but the change of focus from the front month to the second month typically occurs with about seven trading days remaining to the front month’s settlement date. There are some other instances where open interest in the second month surpasses that of the front month with more time to expiration. However, with the U.S. election on the horizon it is interesting that VSTOXX futures traders are already looking beyond November expiration. Since the focus has moved beyond November, I decided to seek out some trades using December and January VSTOXX options to see how large volatility traders are positioned going into late 2020 or into early 2021.

The first trade occurred on Monday October 26 and uses December options. It is positioned for either a VSTOXX run to 40.00 or remaining below 30.00, with a preference for a run to 40.00. When the spot index was at 31.75 and the December future at 28.00 a trader purchased 1,000 Dec 30 calls for 2.80 and sold 2,000 Dec 40 calls for 1.425 each. These combined transactions result in a credit of 0.05 for each spread.

Long 1 VSTOXX Dec 30 Call + Short 2 VSTOXX Dec 40 Calls

One by two spreads like this are attractive for VSTOXX option traders since it makes a profit if the index does not trade higher, but also allows the position to profit if there is a market event that pushes VSTOXX to elevated levels. This trade matches this outlook and would work as long as the rise in VSTOXX does not mirror the moves witnessed earlier this year. This spread will realize a 0.05 profit with VSTOXX under 30.00 and has a maximum potential profit of 10.05 with VSTOXX at 40.00. The risk is a large move to the upside with losses accumulating if VSTOXX® rallies past 50.00.

A second trade, also positioned for a move to the upside, hit the tape on Friday October 30. This trade occurred with spot VSTOXX around 36.00 and the January 2021 VSTOXX future contract at 28.55. The specific trade involved a seller of 1500 Jan 20 puts at 0.80 who then bought 1500 Jan 32 calls for 4.175 and sold 1500 Jan 38 calls for 3.05. This results in a cost of 0.325 per spread.

 

Short VSTOXX Jan 20 Put + Long VSTOXX Jan 32 Call

+ Short VSTOXX Jan 38 Call

This second trade is a bit more aggressive than the first trade as VSTOXX needs to settle above 32.00 at expiration in order for the trade to be profitable. The spot index was in this range when the trade was executed, but the January contract was at a discount to the future. It is also a bit aggressive as losses may be realized if VSTOXX moves below 20.00. The payout at January expiration tops out at 5.675 points if VSTOXX is at or above 38.00. The trade loss is the same as the cost of the spread (0.375) if VSTOXX is between 20.00 and 32.00 at expiration. As noted the real risk for this trade is a volatility crush with VSTOXX returning teens, a level that does not seem likely, at least over the foreseeable future.

A final option trade looking past the election and into 20201 was put on back on October 12 when the spot index was in the low 20’s. With spot VSTOXX at 22.10 and the January future trading at 24.10 a trader sold 2,000 Jan 48 calls for 0.825 and purchased 2,000 Jan 80 Calls for 0.175 resulting in a credit of 0.65 points per spread.

Short VSTOXX Jan 48 Call + Long VSTOXX Jan 80 Call

Unlike the first two trades discussed in this space, this trade is positioned for VSTOXX to not rally to elevated levels. As long as VSTOXX does not rally over 48.00 the trade. In this case the potential loss, which tops out at 31.35 points, is pretty steep compared to the reward of 0.65. However, as noted, for this trade to incur losses of that magnitude the market would need to return to the uncertainty that hit the market in early 2020.