Thursday, August 17, 2006

VIX Options

The VIX looks like a really interesting possibility for call options, and I got some ideas about it from this article. The VIX "price" is range bound, has high volatility, and has rock solid support at 10. Open interest on specific contracts is often in the tens of thousands.

Right now, VIX is in the mid-12 range:
If it drops to the mid-11 range or lower, it becomes increasingly attractive for a call option play, since historically the VIX hasn't stayed that low for very long. For timing the entry, looking at a resistance bounce on the SPX would be appropriate, since the VIX is a contrarian indicator for the SPX.

For expiration month, take a look at the VIX $10 strike calls (prices as of 8/16 intraday):
Nov 2006 - $5.90 ask
Feb 2007 - $6.20 ask
May 2007 - $6.50 ask

Only 30 cents for 3 months extra time. Wow! And if you look at the price history of the VIX $10 call:
Even if you bought it at its highest peak and sold it at its lowest low (worst-case loss scenario), the loss is still under 50%. Of course, we can definitely do better than that with the entry and exit, so the probability of 50% loss for a VIX $10 call looks very low, as long as we close the position at least 10 weeks before expiration. On the upside, a 5-point move in the VIX corresponds roughly to a 25% gain for Feb07 $10 call. (The higher strikes, of course, have more potential upside and more risk.)

So, I am thinking about a VIX $10 Feb07 (or May07) call after a confirmed resistance bounce in the SPX. Exit would be at a support bounce on SPX chart.


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