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Writing Calls on Volatility

I picked up this idea from Jeff Augen’s book, "Trading Realities: The Truth, the Lies and the Hype In-Between."  Augen has written a fine series of books on trading options and I have bought and sampled from all of them.  He notes the favorable risk/reward profile on buying VXX, which is a ETN attempting to track the short-term futures on the VIX, and selling at-the-money calls on it while the VIX is low.  Augen notes that theoretically you could lower your cost basis in a year’s time to almost zero using this method every month.  But it gets even more interesting using weekly options.  I bought VXX ETN at $14.92 today and sold the $15 strike on the October 22 weekly options for $.58.   That is about 3.8% profit if VXX does not move at all.

That is what I’m trying to average on a trade per month!  

Let’s take a look at the one year chart on VXX:

VXX chart 

You can see how low VXX has dropped.  Unlike a stock you know this chart is not going to drop to zero.  Volatility cannot disappear or go bankrupt.  There will always be some level of volatility, so there is a limit to downside risk.  The VIX, which is a measure of put buying, closed at 21.68 today, which is fairly low volatility.  If you had to say which way volatility is moving right now, is it more likely to go up or down in the next month?  I’m voting for up, since we have earnings season, elections and a rally that looks like it could roll over at any time.  With a low VIX and higher expected volatility events, doesn’t it make sense to sell covered calls on volatility at least until the VIX clears 25.  

I’m planning to sell the weekly at-the-money calls up to that point, which may only be one week if the market drops.  I’m sure speculators could arrange more profitable trades, but I am looking for income and retirement investments, so I’m not getting greedy and buying calls or some other idea.  I am considering selling at-the-money puts in my margin account.  Let me know what you think of the idea.  The risks I can foresee are poor tracking of the VIX by VXX and that volatility is driven into oblivion.  But the VIX rarely drops below 15, which would be a 25% decline.  I can cover that in two months of at-the-money weekly calls and I just don’t think the VIX will drop that much in the month ahead.


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  1. I like the idea Rev!


  2.  Nice.


  3. splendid idea--will look at it tomorrow--


  4. This is interesting with respect to this idea. I will certainly look into this further.
     
    http://www.ipathetn.com/pdf/iPath-Tax-FAQs.pdf


  5. Rev, Which of the Augen books do you recommend most? Thanks.


  6. I find this idea myself and testing this one month. If vxx fall very sharply, you want more time to sell premium. And you must started small size and add more after fall. I started month ago with vxx 17,8. Today I have 1000 av 16.08 and I collected 415 premiums and own 5 nov17 short C 0.9 and 1 todays 15 C 0,25 what I sell yesterday. My test is building for 3 month. For cover I own also some vix dec 22,5P at 0.8


  7.  Revtodd:vxx  How does it work when you sell puts that end up in the money with the vxx since there is no physical underlying? thx


  8. Rev, you might want to check Adam Warner’s http://dailyoptionsreport.com/. He has plenty to say about VXX. Might have to search his site, but he is not fan of that ETF and for good reasons I think! 


  9.  redlog – since VXX is an ETN you end up owning VXX at the strike price.  Which is fine in a low volatility environment.  If you like owning it at that price, then just write ATM calls on what you own.


  10.  stjeanluc – I am not a fan of the VXX ETN as a pure investment vehicle either.  However, the tracking errors compared to the VIX are not such a big factor in the short term when selling weekly options against it.  It is like TBT, SRS and UNG which have their uses, but can be frustrating if you are counting of pure tracking of the index.


  11. FYI….. VXX is great to finance purchase of disaster hedges (TZA, FAZ, etc.) because the margin requirement for selling VXX puts is very small compared to huge margin needed to puts on ultra ETFs. Be warned VXX is super volatile. Yesterday it went from 14 to 15, then closed around 14.70 even though the Dow dropped only 1 point. Only 1 month ago VXX was 18, now it’s down to 14.50 or so.


  12.  Kururi67 –   I think "The Volatility Edge" is the best intro to his work.  I just finished "Trading Realities" and I think it is a good read for the retail trader.