The Option Pit VIX Light Is Red, Volatility Will Drop.

Hey Traders,

The market is at all time highs … again.

The VIX is getting back near 15 … again.

While I think we could see the VIX head even lower, A LOT of traders have asked me what I would do to hedge this market.

Want to know? Read on …

The VIX is sitting at about 16.50 as I write this.

The September  VIX future, though, is still sitting over 19:

This makes owning a single long call VERY difficult as a VIX trader …

Why?

Because for any call to end up in the money, we need a pretty big VIX move.

Without a strong VIX spike, a nominal rise in VIX could actually be met with DECLINING futures prices …

Especially as we get nearer to expiration (the convergence of VIX futures and VIX cash MUST happen by September 15).

Even so, many traders look at this market and WANT to put on a hedge.

So how can you do it?

The answer is a call spread.

One thing about VIX is that as you go up in strike price, implied volatility (IV) gets more and more expensive.

Take a look:

What you are looking at is skew, the relationship between at-the-money (ATM) options and  out-of-the-money (OTM) options.

This means calls get more and more expensive in relative terms as strikes go higher.

This means that September 20-strike calls have an IV of 113, and a cost of about $1.30…

The September 30-strike calls? The IV is 180%, and they STILL price at over $0.40 a contract.

That means I can buy the 20-30 call spread in VIX for about $0.90.

That is a pay out of about 10-to-1 if VIX blows higher.

So,  generally … I ALWAYS spread on hedges.

So, when people ask me how to hedge using VIX …

The short answer is simple: buy a call spread.

Your Only Option,

Mark Sebastian