29 July - Panic but therein Lies Opportunity

So with this morning's rout and VXX hitting fresh highs, I decided to square up the remainder of my calls.

As the naked calls purchased early this week expire today, I'm finding it difficult to replace it with more outright calls as IVs have gone way through the roof. Moreover, I see a strong potential for significant mean reversion in VIX futures on any positive news. With that in mind, I will likely purchase the $25/$28 call spread for about $0.75 expiring 5 August to hedge my position on the upside over the next week. 

In addition, VXX option premiums have gone crazy, with the 19 August $25 straddles going for about $4.75. This is way too high in my opinion and presents a compelling opportunity. With a breakeven close to $30 on the upside, I'm pretty content as I don't see VXX rocketing another 20% higher, unless of course the US defaults (a downgrade is pretty much priced in by now). Even if such a scenario were to materialize, I don't think think VXX will end up much higher taking into consideration VIX spot and future levels. Now on the downside, $20 does seem to me like a more probable target. However, considering I am short VXX as my core position, I am happy to take this risk. Furthermore, I intend to hedge this position by going short on more spot if a successful agreement is reached, although VXX would probably have gapped quite abit lower by then. Also, IVs are likely to die down as spot VXX moves lower.

Finally, I do still think an agreement will be reached but am now more pessimistic that it'll be completed over the weekend. Perhaps an eleventh hour deal on Monday?

27 July - Finally, Some Realized Vol

Within the first hour of trading, the VIX is up 10%, the August and September futures are up between 4 and 5% and the S&P is down over 1.3%. I believe today's sharp spike is due to the complacency I observed on Monday and Tuesday (more so Monday as volatility futures had begun a sizable move yesterday). Such complacency is often followed by panic and this often causes the market to overreact.

Although I've sold some VXX against my calls as VXX rose this morning and throughout yesterday, I still have half the calls with no offsetting position and am carrying quite a bit of positive delta. Now comes the hard bit - what should I do now?

I would normally be tempted to sell more VXX. However, given that such a move has occurred on Wednesday, I fear that if no deal is done, we'd see similar moves over the next two days. Thus, there may still be some upside in VXX and definitely a lot of downside in the S&P (as the rise in VXX has by far outpaced the decline in S&P).

With the way things are playing out, I believe it will take them at least the weekend to come to an agreement.

26 July - No Resolution Yet

In light of the comments I made yesterday, the S&P is still holding up modestly, though the VIX and its futures have begun to price in a worst case scenario.

I am going to begin scaling into a short VXX position against my VXX calls as these are way past their breakeven if you bought them early yesterday. Remember that in the end, I do believe a deal gets done, though I think it is an equity sell-off is in the cards this week before both sides resolve the situation.

Another thing which looks attractive to me is a short S&P/short VXX pairs trade as the spread has widened quite a bit. However, it is imperative that this is exacted using an appropriate ratio.I will probably be doing so over the next few days if these oversized VXX moves (relative to the S&P) continue.

25 July - Some Thoughts

The S&P 500 is looking pretty resilient this morning despite the weekend's failed debt-ceiling talks and overnight downgrades. VIX futures have not reacted as much as I feel they should have.

Although I believe a deal will ultimately get done as it is in both their best interests, I feel that equities and the VIX are showing a bit of complacency. As I already have a modest short position in volatility, I will use this morning's strength to get some of the weekly ATM VXX calls.

I still like the short VXX trade at this point in time but I feel we might see some panic and selling of risky assets later on in the week if a deal has not been made yet. If such a scenario emerges, I will then look to unwind my calls or sell some spot against my calls.

22 July - Typical Friday Trading

The morning session of London trading has been very quiet so far, with estoxx sticking to a 12 point range. Bunds are marginally down on the day and peripheral spreads over Germany continue to come in sharply from yesterday - 10 year Italy and Spain are 10 bps tigher, and Greece is 200 tighter (still 3000+ to go though!). Currencies are holding a tight range with the exception of AUD and NZD which are strongly bid . . . note that they stayed fairly stationary while EUR and EURCHF were rallying last night, so this may be a catchup of sorts. FX vols are tanking dramatically across EUR pairs, 1Y EURCHF some 1.5 vols lower than pre-leak yesterday.

My view on the leaked meetings from yesterday is that the announced measures are enough to provide a sustained 6 months of relief from Euro crisis tensions, similar to the reaction post-June 2010 Greece and post-November 2010 Ireland. Keeping this in mind I think there's value in entering a long Eurostoxx position vs a short S&P500 position, via Sep futures. Estoxx is trading around 2800 where it was 3000+ only 3 months ago, whereas S&P is brushing up against its pre-2008 highs . . . I also expect this trade to be fairly well hedged and probably outperform in the tail-risk scenario of no agreement being reached on the US debt ceiling.

Charts and ratios to follow.

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