Saturday Review For July 23, 2022

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Friday’s VIX close at just over 23.00 was the lowest closing level for VIX in 3 months. The S&P 500 had a good week. However, it is over 400 points lower than the closing price back in April when VIX was at comparable levels. This sort of divergence, where VIX is making new near term lows but the S&P 500 is not near a new high, results in two things. First, we get the “VIX is broken” articles, something we encourage readers to ignore. More importantly, the S&P 500 will often continue higher. For stock bulls, the recent VIX – SPX relationship is encouraging.

July VIX settled on the open last Wednesday. This places August in the front month position. The curve shifted lower in a parallel fashion last week. Now the shape of the curve is very close to textbook contango, another data point that gives stock bulls some hope.

In the ETP space the long funds all took a dip. The longer dated long funds (VXZ and VIXM) both dropped more than 1%. This is not unusual, but caught my eye as it may indicate equity market bullishness through the third quarter. The short funds both gained with SVIX the big winner gaining almost 4% on the week.

Looking forward for a moment, this is a FOMC week and there was a bit of brief drama around just how much the Fed will raise rates this coming week. For a very short period of time the market was discounting a 100 basis point hike, but that reverted to a 75 basis point hike. The chart below shows the CME Fedwatch odds of a 100 basis point hike at the next meeting.

This figure finished the week just below 20%. This means there is an 80% chance of the hike coming in at 75 basis points.

The first trade we want to discuss is a basic put purchase. However, it is in the VIX complex, which means it is not a simple as when a put is purchased on an index or individual stock. This trade occurred with spot VIX at 23.03 and the August VIX future at 25.85. A trader came in and purchased 200 of the VIX Aug 25 Puts for 1.80 each. The payoff with the future and spot VIX highlighted below.

Note spot VIX is just below the downside break-even point for this trade. Short volatility is often a gut wrenching experience. However, in this case, the potential maximum loss is defined and the option premium includes no time value, when compared to spot VIX.

Another interesting trade, also looking for lower prices in VIX came late in the day Friday using UVIX (2x short VIX futures) options. With UVIX at 12.92, a trader bought 50 UVIX Aug 11 Puts for 0.68 and sold 50 UVIX Aug 11 Puts for 0.30 each netting a cost of 0.38 and a potential payoff of 0.62.

The maximum profit requires a drop of 22.6% which is no out of the possibility over a four week period. Especially if VIX continues to drift lower and contango continues to rule the VIX term structure.