Today the VIX moved sharply higher by over 11%, and the financial media blamed fiscal cliff negotiation bickering. The VIX futures in the front month rose 6% and now sit in virtual lockstep with the VIX:

VIX January Futures: $17.10

VIX January (VIN): 17.36

The VIX is actually in slight backwardation, as the next month (VIF) is sitting at 17.25. Yet the VIX futures are trading at $17.90, comfortably in contango. Therein lies a nice set-up for a synthetic VIX short trade, using VIX futures in the VXX exchange traded note.

A nice trade exists in the January VXX $28 puts, for around $1.20. The VIX futures falling to  16 would do the trick, when along with the contango daily headwinds and positive seasonal bias in the equity markets could easily bring the VXX to below $28. That would generate a return of nearly 100% in the VXX $28 Jan put. The VXX on Wednesday held 100% January VIX futures.

The major risk to this strategy is clearly the path of fiscal cliff negotiations. Yet, a resolution of some sort will occur before the expiration of this contract. And what if the deal is made before January? That is how strong the move to the downside in VIX could be in the next two weeks.

Normally, considering where we are in the OPEX cycle, we would potentially opt for VXX weeklies, using our proprietary Volatility Wave model. (This is a VIX forecasting tool that allows us to predict implied volatility movements. Contact us for more information.) Yet the fiscal cliff wrangling is causing us to push out the trade, yet we can still maintain exposure should a deal come early.

We will post the trade and prices this morning when the position is established.

Trade Update: Long Jan VXX $28 put at $1.18. 9:56 am.

Trade Update: added at .92, 3:38 pm.

Trade Update: added significantly at .53 on 12/21 3:40pm.