Short-selling PUT is done when one is expecting the underlying equity would go up. I know open positions in anticipation of VXX going up is not a good strategy in the long run. VIX and VIX ETPs are most of the time in contango, so a question I had was “Would option time decay be able to offset the contango effect?”.
Can Theta Value Off Set Contango Effects for VXX Options?
I decided to do some research and ended up on this blog post at sixfigureinvesting.com which is run by Vance Harwood. I had been following him since I started learning about VIX trading so this was not a surprise.
Below is a question I posted in the comment, and he was kind enough to give me some pointers. Apparently, he developed a solution to predict VIX ETPs’ prices.
Here is a post that he explains the overview of how it’s done – https://sixfigureinvesting.com/2018/08/projecting-svxy-vxx-uvxy-tvix-prices-with-vix-term-structure/
Here is a post about the service he is providing – https://sixfigureinvesting.com/2018/08/volatility-etp-projection-from-stable-vix-future-term-structure/
Predicting VXX contango effect
Based on Vance’s explanation, the prediction model he came up with is based on the previous 40 trading days data. Using the prediction model, starting on Nov 28th, 2017, VXX at around 32 initially would be at around 28 by Dec 28th, 2017. This is about 12.5% drop in one month.
A similar result can also be obtained by using the contango value found on Vixcentral.
The contango effect was 12.86% on Nov 28, 2017 and VXX was around 32. (NOTE: the contango effect is similar to Vance’s model).
32 x 12.86% = 4.12 (it would drop 4.12 in one month assuming contango effect doesn’t change for the next 30 days).
Subtracting 32 – 4.12 = 27.88. Which means in one month (around Dec 28th, 2017), the VXX price would be around 27.88.
How to use these data?
Now that we know 27.88 would be the lowest VXX price if the VIX price remains steady in the next 30 days.
In other words, the pure contango effect would bring the price of VXX down to 27.88.
This means if we sell VXX 27 PUT on Nov 28, 2017, in theory, we should be able to profit from time value decay or even get out earlier if there is a spike in VIX.
Assuming VIX would not go down further at expiration or contango would not accelerate more than 12.86%, short selling VXX 27 PUT should be a solid profitable trade.
What do you think? Am I thinking this correctly?