Profit purely from VIX contango?

[blackice 5]

Hi everyone,

Learned a lot from this forum, I'm wondering if such strategy would be possible:

1. During VIX low period (like now), VIX futures are usually in Contango, which means the futures price is higher than VIX index and this extra amount is reducing as time goes
2. Build position with VIX options (essentially it's the option on VIX futures) to short VIX futures. Suppose VIX index does not move, this position will have more and more profit since VIX futures price is dropping due to Contango
3. Build position with SPX options to short SPX, with the goal to neutralize the P/L impact to position in (2) when VIX index moves. Basically, if SPX goes down, VIX index goes up, and position in (2) shows loss, but position in (3) is short SPX, so it will show gain.
4. If we could build a good position in (3) so that it will just neutralize the P/L impact from SPX move in (2), then we are actually making stable profit from VIX futures contango

Of course we need to consider time decay, so we want the theta of (2) and (3) be neutral or positive.

Just a random and raw idea, so would welcome any comments.

 

[Yowster 8,047]

@blackice- SO already has trades that do exactly what you outline.   The VXX put diagonal trades are designed to take advantage of the VIX futures contango, which is it's norm.  VXX is built using the front 2 months of VIX futures so its constantly selling futures about to expire (lower price) and buying futures up to 2 months out (higher price) thereby causing cause the VXX price to go down when the VIX futures are in their normal contango state.   This is exactly what you refer to in your (2) trade.   Your (3) trade is a hedge, which SO has with the VIX risk reversal and VIX strangle trades.  Maybe building a better hedge is possible, but the basic premise of what you outline is already in play with SO trades.

[blackice 5]

6 hours ago, Yowster said:

@blackice- SO already has trades that do exactly what you outline.   The VXX put diagonal trades are designed to take advantage of the VIX futures contango, which is it's norm.  VXX is built using the front 2 months of VIX futures so its constantly selling futures about to expire (lower price) and buying futures up to 2 months out (higher price) thereby causing cause the VXX price to go down when the VIX futures are in their normal contango state.   This is exactly what you refer to in your (2) trade.   Your (3) trade is a hedge, which SO has with the VIX risk reversal and VIX strangle trades.  Maybe building a better hedge is possible, but the basic premise of what you outline is already in play with SO trades.

@Yowster  Thanks a lot for the info, Yowster! I do see VIX strangle / VIX risk reversal trades open now on SO. Are these trades set up as hedge for VXX calendar on SO? I looked at their discussion posts and didn't find info about hedging.

 

[Yowster 8,047]

@blackice- Well they may not officially be called hedge trades in the SO trade alerts and discussions related to them, but I consider them as such.  They take larger VIX upward spikes to make large gains, and those spikes are typically during significant market downturns - scenarios which can negatively impact our calendars and VXX diagonals.

[blackice 5]

7 hours ago, Yowster said:

@blackice- Well they may not officially be called hedge trades in the SO trade alerts and discussions related to them, but I consider them as such.  They take larger VIX upward spikes to make large gains, and those spikes are typically during significant market downturns - scenarios which can negatively impact our calendars and VXX diagonals.

Very interesting. Thanks, Yowster. Any work has been done to quantify this kind of position for hedging VXX diagonal/calendar?