With 17% of the U.S. Federal government shutdown, let’s shift this week’s focus to playing the broader market through volatility, specifically through use of CBOE’s cash-settled VIX options. The October VIX future contract closed Monday’s session at 18.48, up 10.00%. VIX futures subsequently opened Tuesday’s session down slightly.
VOLATILITY PREMIUMS
As the shutdown drags on, investors and traders seem willing to pay a premium for volatility. The SPX is within five points of its close (1681.55) on September 30 (the day the government officially ‘shut down’). That same day, VIX futures closed at 16.18. So while U.S. equity markets have not necessarily seen much impact from the shutdown, volatility premiums seem to imply the situation is still on the mind of investors.
PLAY IT WITH AN IRON BUTTERFLY
To trade my view that volatility is overpriced, I will look to an Iron Butterfly with VIX options. By selling 17 strike straddle, I’m also somewhat bearish from a volatility standpoint (i.e., I believe the U.S., the cornerstone of the global financial system, will pay its bills on October 17). To avoid the blowout risk of a naked short straddle, I will also purchase the 14-20 Strangle, and thus limiting my potential for loss.
THE TRADE
Sell the VIX Oct 17 Stradde, Buy the Oct 14-20 VIX Strangle for a net credit of $1.80. Also known as a ‘Long’ 14-17-20 Iron Butterfly.
Risk: $120 Per 1 Lot
Reward: $180 Per 1 Lot
Breakeven: $15.20 and $18.80
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Read a related story on how the S&P 500 E-mini could react to the on-going shutdown.
