Long call spreads, short volatility

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Near-term volatility is likely to be dampened once again, as people revert to buying the dip. Shorting volatility by buying call spreads on the SVXY index is a safer asymmetrical play than being outright short VIX futures.

The risks are: US equity selloff ends up being much more sustained than we have seen so far, or it just takes longer for the market to bounce back. At the end of the day, our risk is capped at our premium outlay.

The SVXY index – which is a short VIX index – moves in the opposite direction to the VIX.

For the last five years, it has done a relatively consistent job of rallying every time we’ve had a pullback (spike in the VIX).

In fact, the only other time that we’ve had a such a big break as the one we are in now was in the third quarter of 2015

Management and risk description

For the Strategic Book, we are long a vertical call spread, buying out-of-the-money 72.50 strike calls, with a December 15 expiry, risking 50 bps, paying 9.35 in premium, while selling a 92.50 strike call with the same expiry and receiving 3.47 premium, for a total net premium outlay of 5.88.

The maximum profit should be the call spread strikes plus the net premium outlay, in this case [92.50 – 72.50] +[ – 5.88] = 14.12, or about 2.4x the cost of the call spread.

Parameters

 Source: Saxo Bank

SVXY 2-year chart

SVXY 5-year chart

Source: Bloomberg

— Edited by John Acher

Non-independent investment research disclaimer applies. Read more
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