Rolling Over my VIX Options

The VIX has become insanely cheap.

The VIX index represents fear – or lack thereof – in the market based on the premiums built into option prices on the S&P 500. My back-of-the-envelope analysis:

1) Its a good time to buy options (I especially like deep-in-the-money call options on stocks that don’t pay dividends such as Newmont Mining)

2) There is way too much complacency in the market. I am not a “World is Ending” type of person but I do think that there is substantial risk in the market. Here’s a quick list of risks:

• Global structural problems (US Deficits/Bretton Woods II/Capital Flows, etc., etc.)
• Lofty stock valuations in the US and around the world
• Slowing economic growth in the US
• Rising inflation around the world
• Housing bubble(?) in the US might be deflating
• Gold is steadily rising (look at the price curve on gold futures and you will see that you can sell long-dated gold futures today and guarantee a ROR > Libor)
• Commodity price volatility
• Torrid growth in India & China

Therefore, I think that owning gold and the VIX is a good hedge against today’s complacency. The only problem with the VIX is that you cannot buy the index outright – you have to buy options. These options are, unfortunately, very pricey. Nevertheless, I plan on buying some more long-dated calls on the VIX and rolling them over frequently. With this method, I won’t lose too much of the option premium derived from the time value.

Action Plan:

Tomorrow I will sell two VIXEB calls for a ST loss of $440. I will buy two VIXHB calls to replace them.

I am quite comfortable taking ST losses in the VIX using this strategy. For one thing, I’m pretty sure I won’t be negatively impacted by the wash sale rule. Also, I would imagine that, over time, this strategy will become profitable if the VIX experiences any kind of pop.

If, on the other hand, the VIX keeps going down, I will presumably be making healthy gains in the my stock portfolio which will more than offset the ST losses I’m taking in the VIX options. Given my conviction on this matter, I should be buying a lot more than 2 calls but that is what I will stick with for now. I haven’t really discussed this strategy with an “expert” so before I do, I want to keep it small.