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Consistent income trading options: VXX and UVXY in low volatility

VXX and UVXY in low volatility
VXX and UVXY in low volatility
OptionsAnnex.com

In our quest to understand trading options for consistent income, we often look for good strategies in a low IV (implied volatility) environment. One strategy often considered is to trade volatility products, such as options in the VXX and UVXY.

The VXX is a volatility product based on the weighted average of the front- and second-month VIX futures (/VX). The UVXY is 2x the VXX, which means its daily percent change is twice the VXX daily percent change.

As a derivative of the VIX, the above two volatility products are balanced daily (by selling the front-month VIX future, and purchasing the second-month future). This introduces some delay (or drag). The question: can we take advantage of this drag by buying an ATM (at the money) spread, where one option is one strike in-the-money, and the other one strike out-of-the-money); a Put debit spread?

Incidentally, the VIX futures are typically in contango; this means the front-month future is priced lower than the subsequent month; hence, a Put debit spread, in anticipation of IV going lower, makes sense.

To determine if ATM Put debit spreads are profitable as IV declines, Tasty Trade recently ran a test from January 2012 through May 2014 (a total of 30 months).

The test criteria was as follows: enter a trade when the VIX drops from above 17 to below 15; use the option chain that is closest to 45 DTE (days till expiration); buy a $1 wide Put spread in both the VXX and the UVXY; and hold the position till expiration.

The results: there were only 14 trades entered during the test period (out of 30 months). Both the VXX and UVXY had positive P&Ls ($101 vs. $253 respectively), and high percent winners (71% vs. 86%).

In conclusion, this looks like a winning strategy. However, the profit is very low, along with the number of trades (not statistically reliable). Also, while the percent winners tend to indicate a consistent approach, the low volume of options traded in the UVXY make filling trades near the mid-point unlikely.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.