Is This Why VIX Is Behaving So Strangely?

Tyler Durden's picture

Hedging basic equity positions with options is nothing new. Buying Puts or selling calls to protect or enhance your position is not uncommon. The relative price that is paid (or received) for that protection is the implied volatility - it is the lever with which supply and demand for protection is turned (and is highly anti-correlated with equity movements). Strategies to hedge large equity positions have become more and more complex (as more and more complex instruments have become available).

One such strategy is to buy VIX calls against a long S&P 500 position - the best being that if the long equity position gets in trouble, VIX will rise and the call will lever that gain to offset MtM losses - i.e. a hedge. But VIX calls can be expensive and so, as we noted from Barclays, a more advanced strategy is to buy risk-reversals (long out-of-the-money VIX calls against short out-of-the-money VIX puts) which creates a 'synthetic long volatility position' to hedge the long equity underlying position. Given the leverage of the options, typically this has been done at 30% of notional to reduce the cost of the hedge.

SPX Hedged with VIX Risk Reversals


VIX call options are expensive due to the high implied realized volatility premium of VIX options. Cost of buying the call options can be reduced by selling OTM put options on VIX. Similar to the call hedge, we buy one-month 20% OTM call options to hedge SPX but also sell one-month 20% OTM put options on VIX to reduce the cost of the calls. The notional of VIX call options bought and put options sold is kept at 30% of the equity portfolio. The premium paid (or received) from buying and selling the options is borrowed (or deposited) at the Fed funds rate. Similarly, the equity position is adjusted according to the gain or loss from the option positions and the interest amount at each rebalance date.


Historically, VIX has not had many spikes to the downside and even though OTM puts are cheaper than OTM calls, they are still a good sell, in our opinion. The risk of being short these puts is mitigated by the convexity of VIX to SPX which ensures that the downside to volatility is capped. In terms of performance, this works the best amongst the VIX options based equity hedges.

This strategy has been very successful in hedging downside in the S&P 500 since the crisis began. The last few weeks has seen the return from the hedged strategy converge to the S&P 500's performance and we suspect this has been the trigger for exits - i.e. given the clarity we have now relative to 2008 on just how FUBAR everything is, let's reduce size as opposed to hedge.

The performance of the SPX + VIX Risk-Reversal strategy has perfectly converged (see below) from the cliff-edge of the financial crisis - we suspect the highly active strategy along with concerns over technicals in short-term vol may be leading many to unwind such synthetic positions.

This unwind of a very popular risk-reversal hedge in VIX options is implicitly like selling volatility - hence the dramatic outperformance of front-month vol even as stocks and credit are not soaring to such highs.

Watching the skew between VIX calls and puts may give us some sign that this exuberant compression is over.


Source: Barclays

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Comay Mierda's picture

because vix is a scam

5880's picture

Said the guy who doesn't understand it

The Monkey's picture

It's pretty simple. Buying volatility the next couple weeks is a money loosing proposition. You have Apple, which will probably jump 10%, moving the whole market with it, and you have the Fed, which will come out with something.

End the end, all of the shorts will have been purged and the market will retest it's top.

Easy money.

Xibalba's picture

Craaple is RED with the markit up....And the FED concept has been a massive failure.

The Monkey's picture

If Apple was bid up to $700, that would be bearish. It's going to pop and take the market with it - the Fed is a magnificent tailwind.

Apple at current prices is bullish for the market as a whole, unless they miss, which has about zero percent chance of happening (in spite of the venerable 4gs anchoring their lineup).

pkea's picture

finally looks like a good chance to buy vix and go short after earnings and the fed

The Monkey's picture

Depends on price. I have said from day 1 of this correction to plan on the S&P making it all the way back to 1421.

DeadFred's picture

1460, there are a lot of shorts out there.

The Monkey's picture

It's possible. Looks like smooth sailing for a while.

pkea's picture

blood in the water is always a good buy sign but I would still wait a little to buy it. They definitely beat vix and its call holders to the bloody pulp


 interestingly today vxx was up first time on the 100 up for dow day

CClarity's picture

VXX is the real scam.  What a flawed construct as it actually works.  Know many who got ploughed in it.  

Was shocked to suddenly see VIX @ 15.75.   Yet another ruined indicator, but then again, the manipulation and medication is so extreme at this point that I don't think the Fed even reads the Beige book anymore.  It is more an excuse book for whatever they decide they want to do or not do on their omnipotent whim.

Meesohaawnee's picture

i like the word "historically".. historically we have had natural ebbs and flows. Historically we have had corrections, when data is bad or good for that matter. Historically we have buy the rumor sell the news. Historically stocks tend to sell a bit after earnings. Hows "historically" workin out for everyone?

RobotTrader's picture

Some of the leading "wealth destroying" instruments of all time:




3) TBT


5880's picture

Zero sum game

add "casino" to the list

Maos Dog's picture

At least fucking casino's comp you

unununium's picture

Robo, as one who took the other side of your NFLX buy recommendation, I say thank you for the symbols, sir, and god speed.

Fecklesslackey's picture

Unless you short them ... all leveraged etf's "On a long enough timeline the survival rate for everyone drops to zero"

5880's picture

they reflect carry

stupid stock 'gamblers" should educate themselves on futures carry and roll

sablya's picture

The market goes up and the market goes down.  Anything that changes price is potentially a "wealth-destroying instrument" if you're on the wrong side of the trade.  Plenty of people have lost plenty of money on TNA.  Plenty of people have made plenty of money on TZA as well.  

Panafrican Funktron Robot's picture

You sir are apparently unfamiliar with covered calls on weekly options, and the hysterically high call premium associated with all but TVIX in this list.

DeadFred's picture

Ha ha, I've never lost any money on TVIX. Add ERX, ERY and you've covered most all of my bad hair days.

razorthin's picture

If your timing is good, and depending on how highly priced at the time, any of these have been very useful.  I tend to rather short the long 3x at a confirmed inflection, as it has been bloated in price in this bloated market.

Stuart's picture

"Source: Barclays"

This data is from Barclays....and this post then, you're kidding right??  

q99x2's picture

I prefer Viagra.

AcidRastaHead's picture

I'd rather describe it as "A Fiscal Phenomenon"

Hype Alert's picture

The markets forever changed March 2009.

cdude's picture

Forever is a long time and lasts up until another "forever" is declared.

Gene Parmesan's picture

Running out of fuse...

Village Smithy's picture

Nice detective work.

Dr. Engali's picture

Why waste money on a hedge when the Bernank has your back?  It's just a drag on performance.

Meesohaawnee's picture

actually Robo. THE largest wealth destroying mechanism known to man is that thing you have in your pic. You get within 10 feet of that "thing" between the legs and theres a giant sucking sound from your wallet.

BLOTTO's picture


Yea, but they are pretty and some have really really soft skin...



The worst trader's picture

Thanks for the info..........

Meesohaawnee's picture

so the list as corrected....

1:) Pussy



sablya's picture

The last few weeks have seen an incredible unwinding in vol positions.  It seemed to me that after the Greek elections the reasons for hedging had substantially diminished.  At least, it seemed to me that it seemed to the market that this was the case.  The idea of a radical change in vol doesn't really make sense since the VIX was pretty high before the Greek election - but then just deflated.

My thinking was the folks saw an opportunity to beat the crap out of VIX longs but it is over now.  Watch the shorts start to cover as we move forward.  UVXY staged a reversal today even with SPX up nicely, after hitting the downside target of 6.54.  The VIX reversal may presage lower SPX prices in the days ahead.  

DeadFred's picture

Sometimes it's nice to step back and ask yourself "What is it I'm really doing here?" I once bought call options on VXX, not my best play, and realized I owned a derivative on a fund created to more or less mimic an index following derivatives placed on an index that follows stocks indicating ownership in a select group of major companies.

Of course I bought them with electronic representations of a fiat currency backed by nada.

sablya's picture

I guess you're just trying to make a point that it is complicated.  But so what?  Does that mean there is something wrong with it?

long-shorty's picture

Other than the extreme vix spike in the fall of 2008, this "hedging" strategy has been a consistent loser compared to just owning some equities.

But please, Barclays clients, don't stop trading VIX options at interesting prices. We need counterparties.

russwinter's picture

Portfolio insurance, nothing new here, and its misapplication was causa proxima of the 1987 market crash. 

dcb's picture

don't look at me, so much doesn't make sense anymore. I get why the euro is going up, as when we3 hit a new weekly low I expect it to start baouncing back, and look to rebuy uup later, sold a weekl ago or so.

this matches with tbt a but, udn, uup. makes sense. but I can figure out the equities as of late

chump666's picture

We are speeding towards an equity crash, not a correction. 


chump666's picture

...and it's going to start in HK/Shanghai just like in 87.  VIX will be redeemed hard to hedge when the Fed is obsessed with driving yields to 0%.

Payback is coming, gonna be a bitch too.