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18 December 2010 by Surly Trader 0 Comments

By Surly Trader

It is pretty easy to say that on a quiet trading day a week before Christmas (S&P flat at a +.08%), the big news was the 10% decline in the VIX without any relevant news. ?Maybe the VIX thought the passage of the tax extension was?phenomenally?good for lower volatility going forward, but I highly doubt it. ?I received some interesting speculation from some investment banks, but nothing noteworthy. ?One thought it was a lack of gamma hedging after option expiration and another thought that implied was finally compressing towards realized. ?I highly doubt either of them. ?If I remember correctly, I asked the same questions back in April and then the VIX quickly shot up to 40%. ?Amnesia is a common market and investment bank trait.

Why collapse today?

Because the VIX and the front part of the VIX futures curve have fallen off, the VIX futures curve has a record steepness to it:

Nearly 10 vol points between the VIX and the furthest future?!

There are a few ways (and many iterations) to play this vol market in anticipation of a future spike in vol:

  1. Buy the short end of the VIX futures curve or the ETF VXX
  2. Buy the front part of the futures curve and sell the back half (buy Jan and sell a few Jun or Jul 2011)
  3. Buy puts/calls one month out at low implied volatility, delta hedge if needed

Maybe volatility is really coming down to “normal” levels, but I really get suspicious when reversion to the mean happens a bit too quickly for my comfort.


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