Last week I went to the dark side. I shorted uncovered SVXY calls expiring in September.
At the time the trade was executed, 30-day synthetic was trading below 11.80.
That is an exceptionally low level, but I have been around for a long time to know that low can always become lower. However, I could not resist and pulled the trigger because the current shape of the VIX futures curve provides practically no upside for long SVXY/XIV positions.
Let’s consider the most bullish path for short vol strategies where indices continue higher and corrections are limited to less than 1%. In such a scenario VIX index will levitate around 10 whereas VIX futures curve will basically remain flat for the first three weeks of M1 contract with 30-day synthetic hugging 12. Closer to the expiration of M1 contract, M2 will move towards 12 or slightly below whereas M1 will dive down towards 10. All in all, such action would result in a slow upward move for SVXY/XIV to the tune of 2-3% from levels that were present when 30-day synthetic was at 11.80, i.e. at the time of my trade.
Rinse and repeat this same calculation for August and September and the ultimate most bullish result that I was seeing for SVXY was a maximum 10% (unsustainable) move higher from $168 through mid-September. Even if the move becomes exaggerated to the upside, the structure of the VIX curve would make SVXY/XIV vulnerable to strong pullbacks such as the market witnessed on Thursday last week.
Therefore, in my view even if I’m assigned short SVXY at $190, which given the option premium received pits my breakeven at $196.50, I believe there would be many opportunities to exit such a short position below $190 on any of market’s minimal pullbacks.
The reason I didn’t go too far out into the future, is because of my fear that VIX futures curve may reset higher should a market pullback occur in the nearest-term and after such a reset occurs the potential for SVXY/XIV to fly becomes much more pronounced should overall markets blast towards new 52-week highs after a pullback. It is much safer, in my view, to short 3-6 month expirations rather than go longer-term given the potential for short vol strategies to run higher in a low volatility environment after a VIX futures curve resets higher.
The market microstructure continues to be rather contradictory. In every update I typically make a call with regards to my personal view as to the near-term direction of the market and whether there are substantial odds of a pullback/correction. This week I am unable to make that call. I am not sure that sector rotation that we have been witnessing for the last couple of weeks means continuation of bullish conditions. I am cautious and will happily observe overall market action over the next month or two with a mostly neutral SVXY position.
In the meantime, individual names that I have picked up during the past several weeks continue to perform in a more or less positive fashion. My trading account registered another weekly all-time high and is now up 144% YTD.
Account performance YTD