EXAMPLE: VXX 30 DTE X/X+3 ATM SHORT CALL VERT (CONTANGO DRIFT)
As previously noted in other posts, the short volatility product plays I like most are "Term Structure" plays in VIX and "Contango Drift" plays in VIX derivatives, with the preference being toward the latter play, since you're getting in on a pop in VIX and then taking advantage of "Contango Drift" in the derivatives to the downside (in UVXY, VXX; SVXY is an inverse, so you're looking to take advantage of "Inverse Contango Drift" to the upside).
Here's what I'm looking to get into a "Contango Drift" play:
1. A VIX pop to 20 or greater. For various reasons which I've elucidated before, I use the VIX price as a guide to enter these plays and not the price of the derivative itself. That being said, some traders use a 2 SD Bollinger Band as a rough guide as to when they would want to consider an entry. I really can't poo-pah that, since the last two BB touches (indicated by green arrows) would have been winners.
2. An ATM Setup That Pays at Least 1/3rd the Width of the Spread. I generally go with an ATM credit spread for which I get at least 1/3rd the width of the spread in credit (i.e., for a three-wide, I look to get 1.00 ($100) in credit per contract). This may require some "putzing" with the spread, moving it up or down in relation to current price.
3. Roll Out for Credit/Duration If Price Has Not Broken Short Call Strike by Expiry. No one likes to roll out for duration, since it usually means that the setup is "broken" and you'll be booking a realized loss in the short term if you do that. However, with contangoized setups, time/duration is on your side; the longer you hold the setup, the more likely it is that contango will work its fairly inevitable magic on it.
4. Go Small, Since "Shit Happens." Unfortunately, markets don't always "behave" the way we'd like them to. VIX can "elevate" for periods of time that are longer than we'd all like and send the derivatives into temporary periods of backwardation that aren't favorable to these setups; they'll be underwater and you'll be holding them longer than you'd like. Going small allows you to ride out periods of backwardation, as well as keep buying power free for getting into similar setups "higher up the ladder" if that sort of thing happens.
If we do get a VIX pop to greater than 20, I'll post an actual trade setup. In the mean time, hand sitting ... .
Here's what I'm looking to get into a "Contango Drift" play:
1. A VIX pop to 20 or greater. For various reasons which I've elucidated before, I use the VIX price as a guide to enter these plays and not the price of the derivative itself. That being said, some traders use a 2 SD Bollinger Band as a rough guide as to when they would want to consider an entry. I really can't poo-pah that, since the last two BB touches (indicated by green arrows) would have been winners.
2. An ATM Setup That Pays at Least 1/3rd the Width of the Spread. I generally go with an ATM credit spread for which I get at least 1/3rd the width of the spread in credit (i.e., for a three-wide, I look to get 1.00 ($100) in credit per contract). This may require some "putzing" with the spread, moving it up or down in relation to current price.
3. Roll Out for Credit/Duration If Price Has Not Broken Short Call Strike by Expiry. No one likes to roll out for duration, since it usually means that the setup is "broken" and you'll be booking a realized loss in the short term if you do that. However, with contangoized setups, time/duration is on your side; the longer you hold the setup, the more likely it is that contango will work its fairly inevitable magic on it.
4. Go Small, Since "Shit Happens." Unfortunately, markets don't always "behave" the way we'd like them to. VIX can "elevate" for periods of time that are longer than we'd all like and send the derivatives into temporary periods of backwardation that aren't favorable to these setups; they'll be underwater and you'll be holding them longer than you'd like. Going small allows you to ride out periods of backwardation, as well as keep buying power free for getting into similar setups "higher up the ladder" if that sort of thing happens.
If we do get a VIX pop to greater than 20, I'll post an actual trade setup. In the mean time, hand sitting ... .
