This VIX Butterfly Spread has a 4.5 to 1 reward to…

On By Littum

Market volatility remains subdued as measured by the CBOE Volatility (VIX) Index. The VIX is a real-time index that represents the market’s expectations of short-term volatility in the S&P 500 index.

Investors and traders have long used the VIX as a measure of the level of risk, fear or stress in the market.

Yesterday, the VIX index closed at 14.69, which is at the lower end of the range for the year.

Today we’re going to look at a long call butterfly that uses VIX options as a way to profit if volatility starts to rise next year.

A long call butterfly is constructed by buying a call option, selling two calls higher and buying a call even higher.

The trade is entered for a net debit, meaning the trader pays to enter the trade. This debit is also the maximum possible loss.

Normally a butterfly is placed roughly by the money, but today we are looking at placing it outside the money.

Using the January 21 expiration, the trade would involve buying the 15-strike call, selling two of the 20-strike calls, and buying one of the 25-strike calls.

The cost of the trade would be $90, which is the most the trade could lose. The maximum potential gain is $410, which would occur if the VIX closes flat at 20 at expiration. The lower breakeven price is 16.00 and the upper breakeven price is 24.00.

There are three general outcomes with this butterfly.

  • VIX Below 15 – Trade Loses $90. This scenario should be reasonably acceptable to most investors. While options trading is suffering in full, stocks have hopefully been stable or rising.
  • VIX between 15 and 25 – Good for the VIX butterfly, but potentially bad for equity portfolios.
  • VIX above 25 – Complete loss on the VIX trade and potentially large declines in the equity portfolio.

So VIX above 25 is the main scenario that hurts in this case, but how likely is that?

Using VIX options can be a simple and inexpensive way to buy some protection against a sharp selloff in stocks between now and January. The trade can be placed relatively cheaply at $90 per contract.

VIX options behave differently than regular stock options, so it is important that any trader using this product fully understands the risks involved. As always, do your own research and due diligence before risking any of your hard-earned capital.

Remember that options are risky and investors can lose 100% of their investment. This article is for educational purposes only and not a trading recommendation. Always remember to do your own due diligence and consult your financial advisor before making any investment decisions.