EQD Research

Saturday Review For Feb 19, 2022

Feb 19, 2022

By Russell Rhoads,
head of research

Over the past few weeks, I have been fixated on the relationship between July and August VIX futures. Specifically why is July at a consistent premium to the August contract. I’ve highlighted what I’m talking about below.

Volume shows that interest that far out on the VIX curve is not where everyone is looking for trading opportunities. A few years ago, I had the opportunity to interview Ed Thorp and once the camera was turned off I worked in a personal question, asking what he was looking at in the markets. His response was non-specific but he did say he always tries to look where no one else is looking for opportunities. That stuck with me and we know from VIX futures volume that most of the interest is on the shorter end of the curve. So I put pen to paper, looking where others don’t look this week to see if the current July – August VIX relationship is normal and how has it played out over time.

First, from 2011 to 2022, on February standard option expiration day, July has only closed at a premium to August four of twelve observations. Based on this we can say this is not seasonal like some other relationships. The chart below calculates the spread by subtracting the July closing from August. Therefore, when the bar is negative that is an instance where July closed at a premium to August.

Finally, I look at what happened in the three historical years where July was higher than August on February standard option expiration date. Did this slight backwardation predict anything? The chart below shows the answer is not really but there may be a trading opportunity here.

We expect a near dated VIX future to gravitate toward spot VIX as expiration approaches. When July is the front month, August the second and the curve is in contango, the July future will move down the curve more quickly than August. That is as long as we don’t get a volatility event.

The 2021 line turns negative with about three weeks to expiration, but that move is short lived and at expiration, August is at over a 3-point premium relative to July. In 2018, the relationship stays mostly negative until about trading days until expiration. Finally, in 2016 there are a couple of bumps the road, but the relationship eventually moves higher, finally narrowing a bit over the last few days leading up to July expiration. It appears that a very patient trader could short July and buy August in each of these three historical examples.  With very little drawdown in each instance above they could get out of each spread when July is at a 1-point discount to August for a small, but low risk profit.

Checking in on US markets, stocks were lower due to numerous concerns both domestically and on the international front. Volatility indices had mixed results with VIX rising slightly.  VOLQ and RVX lost a little value on a week over week basis.

Turning to trades, with multiple expirations available each week more very short-term trades are showing up in the index option space. This past week on Tuesday afternoon there was an opening trade in the Russell 2000 index option market using options that expired in just over 24 hours. With RUT around 2063 a trader sold the RUT Feb 16th 2110 Calls and purchased the RUT Feb 16th 2115 Calls. Each execution was done at slightly different prices but all spreads brought in a credit of 0.35.

I highlighted the high of the day for RUT on the expiration day. The closest the index got to the short strike was just a hair under 25 points which is a safe buffer. In last week’s Saturday Review I highlighted a very similar trade from Friday Feb 11 using options that expired this past Monday. That trade was executed at the end of the day with RUT at 2031 and consisted of selling the RUT Feb 14th 2090 Call and purchasing the RUT Feb 14th 2095 Call taking in a credit of 0.50.  An updated payoff diagram showing Monday’s high appears below.

Both these short-term vertical spreads realized the maximum profit as the index settled much lower than the short strike of the respective bearish spreads.

I came across one my favorite VIX option structures on Friday when a trader sold 8,000 VIX May 21 Puts for 1.55 each and purchased 4,000 VIX May 26 Puts for 4.58 resulting in a cost of 1.48 a spread. The payoff if held to May expiration appears below.


I have doubts as to whether this trade would be held through expiration. If I were behind this spread I would plan on exiting the trade with a profit target which would be hit when VIX and the May future are in that range of profitability. I’m got these two options on my watch list and if there is an exit trade before May expiry I will definitely report back.

Finally, the very last NDX trade of the day on Friday, was a non-neutral iron condor. I say non-neutral as we usually think of iron condors as trades to execute when we do not think the underlying market is going to move much in either direction. This trade used the options expiring Tuesday (they exist due to the Monday holiday) and strikes that need NDX to move up slightly.

With NDX at 14009.54 (the close of the week!) a trader sold the NDX Feb 22nd 14050 Puts for 156.10 and also sold the 14150 Calls for 82.40. They completed the trade by purchasing the 14040 Puts for 151.77 and the 14160 Calls for 78.12.  All these trades result in a credit of 8.61.

In football we have quarterbacks who can be very specific in where they place the ball. This trader is pretty darn specific with where they think NDX will be on Tuesday, somewhere between 14050 and 14150. That’s a pretty narrow range, but note, if they miss the worst outcome is a loss of 1.39.