The VIX September future dropped by 6% to levels seen before the sell-off:

As the VIX fell to 13:

The VIX futures curve steepened, and contango magically reappeared:

The SPY has retraced 50% of the drop, making Fibonacci fans excited:

So for the bulls, it appears to be all systems go for now. Our short positions on long vol have evaporated in a couple of days, and it is time to start looking at the other side of the coin. I started nibbling at selling premium on short volatility today, knowing that these bull moves can play out for a while. If nothing more, I’m establishing some hedges.

The middle of August into OPEX and just beyond historically sets up bullish, so lets see if this year continues to play by the book.

This week’s newsletter was published last night and the link to subscribe is above.

http://seekingalpha.com/article/2226103-will-vix-expiration-bring-any-surprises

Even I expected a larger move in the VIX today when the S&P was down 25 points, but here is why it didn’t:

These are the stats for the SPY options today. When the SPY was getting nailed, folks SOLD puts and bought calls. More puts were sold than bought and more calls were bought than sold. That is a recipe for a lower VIX, without a doubt. This implies that no one believes that the S&P 500 can actually fall more than a certain amount before dip buyers will arrive. And you can’t blame them, that intraday buy-the-dip trade has seen it’s share of stick saves of late, which are often accompanied by a gap up the next day. When someone else has your back, why worry about selling the tiniest of volatility premium when it shows up?

But when something gets too easy in the markets, eventually it gets taken away or at least burns a bunch of folks to teach them a lesson. Selling puts like this can be hazardous to your health, maybe not today or tomorrow, but it will catch up to you eventually.

I highlighted in the newsletter that the SPY was technically setting up for a down move, and today it arrived. What  happens when there is very little volatility in the options and the index makes a 1% move? This:

This doesn’t even tell the whole story frankly. If you timed a near-the-money SPY put right today, you could easily have made 400%, instead of the 225% seen at the close. Here is a 5 minute chart of the weekly 187 SPY put:

Actually, if you bought it at the open, you could have made 500%. That is what happens when there is no juice in the options. So, while the market is underpricing volatility, that doesn’t mean that you can’t own it in other ways, and this is a prime example. This is a long vol trade without using VXX or VIX.

We may have more trade and volatility email alerts tomorrow, if you are interested, the newsletter link is in the above menu.

First let’s look at the S&P, NDX, and RUT charts (using SPY, QQQ, and IWM for volume profiling):

All three charts are very bearish, with MACDs rolling or crossing on every one. As you can see, MACD does not immediately turn around and head back higher until it resolves itself. It almost always leads to lower prices. Because uptrends do not reverse on a dime generally, (blow-offs aside) you get some chop at the top. That is what we are doing right now. But the canary in the coal mine may be the Russell 2000. It’s already only 2% above the 50 day after giving up 3% this week alone. Unlike the other indexes, it does not respect the 50 MA that much, unlike the S&P 500, which everyone watches like a hawk when it nears the 50.

The VIX during this chop is still dormant. While the media tone has slightly changed from “QE forever” to “QE taper in Jan, maybe”, folks are still not bidding up put options. They have reason to be complacent, November is a great month for stocks historically, #3, and when followed by great Seps and Octs, the chase usually is on to Dec 31st. But you more need buying, and there has been a ton of inflow lately to equity markets. The VIX may be lurking though, for at least an uptick:

When the VIX sits down here, it takes 4-6 weeks generally for it to make an inevitable move higher. At least a move off of the 12-13 level. The good thing about the VIX being so low, is that you don’t have to pay much if you like downside options, anticipating a natural consolidation in stocks. One thing that works pretty well in this scenario are diagonal spreads. Let’s look at one example of how to get your risk/reward in asymmetrical shape.

This is the option ladder via the fantastic LiveVol platform. I like diagonal calendar spreads in this scenario. You would sell a nearer term put at one strike and buy another longer dated put at a lower strike, thereby lowering your cost and giving you the opportunity to make multiples on a market slide. One potential trade would be to sell the SPY $174 Nov 8 put for .40 cents and buy the Nov 15 $173 put for .56, for a net debit of .16. If the SPY stays flat or falls over the next two weeks, this trade will work and could be a big winner.

A rise in volatility will also juice the longer dated put as well. It is very hard to lose significantly on this trade. If the market stays right here next week, without even falling this trade will probably make 50%. If it falls to 174 next Friday, then you are looking at a 5x or more return, as the ATM puts for next week are worth around $1. That is without adding any vega to the put value.

Expect more posts in the coming week with vol trade set-ups.

Now it gets difficult. Is there a short opportunity? Maybe. But the main question is how the real traders react next week. And what transpires in a kind of pointless exercise we will go through to annoy but not remove a tyrant.  I put on a small calendar short vol trade using the UVXY, short the weekly $39 puts for .54, long the Sep 20th $39 put for $3.54, for a net debit of $3. I don’t really care what happens to this trade until the end of next week really, because I want to sell another week against it on Friday or Tuesday. If vol comes out this week, which would be a curve-ball, I will just close it if I get $5+.

The negative roll on the VXX is around .09/day, so the UVXY has a .18/day roll. Interestingly, unlike other leveraged ETNs, it does not hold total return swaps to generate the results, it does it with its own cash backed futures leverage:

This is a day trading vehicle and one guarantee in the life of this thing, regardless of short-term volatility, is that if you short it, you will win. The only risk is to ensure that you do not get stopped out by margin on large spikes in vol. It can easily double in a situation where the futures rise from 15 to 23. Not a stretch by any means.

So the indexes look shaky at best. You would like to see a flush to look for the swing, but that probably won’t happen with so few traders on the desks. The S&P is trying to break the 100 day moving average, which held in June:

The futures curve is reflecting higher risk and uncertainty:

But realistically, history this time of year shows higher average and median volatility:

So this is why you need to be wary in shorting vol right here. If the futures approach the 20 area, that is a much more attractive short vol launching point. But here is an example of a vol put (UVXY Sep $30) getting hammered over the past several days:

If the futures come back to 15 or so, this can clear $1.50 at a price of .55. But you will need what I call a volatility exhale, and it is probably going to take a Fed-via-Hilsenrath leak of the meeting outcome or a quick end to the Syrian uncertainly. Good economic data is bad and bad economic data is bad right now, so don’t look for something there to depress vol. The job report next Friday carries a lot of uncertainty (even though it has a margin of error of +/-100k jobs, so it shouldn’t), so that is just another log to throw on the fire over the near-term.

In the meantime, I grabbed a few weekly IWM puts at $100 for .44, and if the market does not follow through with downside tomorrow, I will be out of that trade. The IWM broke the 50 day after holding up better than the broader market, so it has room to fall to lower levels.

The S&P crossed back above the famous 50 day moving average:

The September future fell back and is almost in buy territory again:

One way of using time decay payment direct payday loans in your favor is to buy VXX or UVXY calendars. One trade that looks attractive would be:

Sell Aug 30 UVXY $38 for 1.75

Buy Sep $38 for $4.60. Net debit roughly $2.85.

This has heavy theta working for you and you can sell against your long for 4 weeks. You could nearly pay off the long position in two weeks and get a free runner into the Fed meeting Sep 17.

The VXX offers a diagonal opportunity to get a free rider into the Fed meeting:

Sell the Sep 6th, and buy the Sep 20th calls for a net debit of .06. This would work perfectly if the VXX sits at $15 on the Friday after Labor Day, then you let the long calls run.

Today you could have made the same money twice in the VXX, selling the Fed, then buying the vol dip. A few wily traders out there are lighting up a cigar today. Here is the VXX 15.5 put. If you bought it at the release, you made a double. If you shorted it right after, you had an outstanding day. This is so realistic a trade, because you know that the VXX holds all September futures in the fund right now and with all of the obstacles ahead for the market, it puts a floor into VXX:

If you’d rather use the VIX future itself, with it’s 15/4 leverage roughly, here is the same thing, as it occurred today:

It is that easy. The VXX options are more treacherous and need to be constantly managed, but this futures trade does not. You buy the future near 15 and sell it when it spikes (set a GTC to sell and walk away). That’s it. Now, you can do this with the VIX options, buying the Sep $12 or $13 call, and selling them on moves, but they have more premium and are more sluggish. An alternative would be the  in-the-money calls a couple weeks out with the VXX, because the negative roll is much less than it has been. Here is how that would have worked out:

This call is not ideal, but it gives you some wiggle-room with regard to time as you wait for a VIX spike. I almost never recommend owning VXX calls, but when the VXX is holding all of one future, and the roll is small, you get a far more efficient VIX vehicle to trade.

Anyway, the futures look like this:

Not much has changed with regard to the my strategy. I’ve harped on the VIX structure for a while now, so go back and read prior articles to understand why the VIX derivatives offer some excellent low risk opportunities right now. I was in and out of the UVXY put spreads today.

I also opened up a weekly IWM put vertical spread at $101/100.5 for .10 that can pay .50 if the IWM ends the week below $101.5. I think you would agree that those odds are great considering we are less 1% away from that target. I love 5-1 asymmetry; you don’t have to win them all to stay in business.

I did one other trade, but I did not tweet it out. I sold a weekly LOW bear call spread for .72 at $45/46. Again, the risk is .28, the return is .72. Get the idea? 2.57-1 risk/reward. Essentially I’m fading a shooting star gap breakout to new highs, and I didn’t want to tweet that out, as I don’t feel great about it as the technicals are mixed. But I have a hard time turning down .72 on a $1 spread.

Still holding all the USO, AGQ, and AAPL positions mentioned yesterday.

October isn’t going to fall significantly anytime soon either. Part of the reason for their stiffness beyond the aforementioned buffoonery in Washington and Fed meeting, is a seasonal factor. Investment managers have what I call calendar risk. They will cut and run without asking questions in the fall if their year of 20% gains is jeopardized. This tendency causes the following seasonal dynamic in the VIX: This a chart of the VIX over time in the 3 OPEX cycle from mid August to mid November. Day 10 is the day after Labor Day. So we have changed from a sell the rip in vol to a buy the dip. That has been working in the VXX:

I’ve been trying to find vol trades, but we’re in a sort of no man’s land right here. I am actually thinking about selling the Fed vol tomorrow, but how much downside is there? I’d rather let the vol come out and try to get long Sep vol on a dip. Lots of stocks are breaking down, and the percentage of stocks above their 20 day moving average is hitting very low levels (hat tip http://vixandmore.blogspot.com/)

Tomorrow may determine the short-term market direction, while the end of August is typically bullish. Let’s see how tomorrow shakes out. I’m still short crude, long a silver calendar (AGQ aug4/sep $24) and long an AAPL spread into the launch, selling weeklies against Sep2, the launch week.

The S&P is sitting right on the 50 day moving average. Note that pullbacks this year have ended the week after OPEX week.

The futures oddly went in opposite directions with August rising and September falling. With only two days to August expiration, the VIX and the August future will have to line up:

On Wednesday, the VXX and UVXY will hold all Sep futures, which enables these products to move faster if volatility spikes, since they are not holding expensive premium in the following month, that acts as a buffer to volatility rising when the ETNs hold half of each month. I don’t see a trade in these right now, as vol is neither high nor low. They could easily move higher or lower, if the S&P fails the 50, or bounces and vol cools.

The September OPEX cycle is a five week cycle, and this can mean very low volatility early in the cycle. It also means that if you like selling weekly options against the next month in calendar trades that you get another week to sell against your long position.

I did exactly that today. Silver is breaking out and this is the traditional season for gold and silver. (see the Commodity Traders Almanac) The trade in AGQ, the double long silver ETF:

Short Aug4 weekly call at $24 for .71

Long Sep  call for $1.71, net debit $1.00.

For four weeks I can sell against Sep and the goal is to have a free runner in a few weeks. I’m also selling more expensive vol in the short call, a bit of vol arbitrage.

On AAPL, the bull put spread trade I tweeted on Icahn tweet day worked to perfection:

Short AAPL $500 Aug 17 weekly put for $13.10, long $490 put for 5.95. Net credit of  $7.15 on a max risk of $2.85. This is an asymmetric risk/reward structure and it paid the full $7.15. This type of trade is beautiful on a breakout or breakdown (selling a bear call spread), because your risk is minimal.

Now the trade (depending on Monday’s open) will be an AAPL calendar, with the long call the September 13th expiration. That is just after the AAPL launch event, so we will probably see that week’s implied vol rise as the event approaches. So you get both theta and vega working for you. The trade will be something like:

Long AAPL Sep 13th $515 call $10.70

Short AAPL Aug4 for $3.15. Net debit $7.55

The opportunity to sell against this will occur for two more weeks, last week of Aug and first of Sep. If AAPL glides higher into the meeting, this trade will work perfectly. Even if AAPL remains flat, this trade will work.

I also added a bull call spread for next week, $500-$510 for $4.00. Max risk $4, potential return of $10 if AAPL closes over $510 next Friday.

500% on near the money index options? I specifically spoke about how weird this was yesterday, that the implied vol was higher on the call side and the market was technically breaking down. That is pure complacency, and they opened it lower and smoked those that were not prepared. Call holders, you held too long. And put holders, where were you? This should be a chart people follow, because it tells you when risk is elevated:

It is not a guarantee by any means that the market is in danger when the ratio falls this low, but it is part of the toolkit, like the MACD, RSI, 10 day crosses, VIX, etc.

Oddly, the futures opened one eye to check out the proceedings, which frankly were boring once the opening marks were set:

I’ve mentioned many times over the last two weeks to get ready for this, that this day was coming. It always does. And the key was to do it from a low risk position, thus the Sep VIX $12 call and the UVXY call spread. The futures ETNs only had negative roll yield left in them, but even so, buying naked calls was not the play. The Sep VIX $12 had almost zero downside.

History shows tomorrow as very bullish – makes sense after folks have been shaken out of their derivatives, no? We will look at the Volatility Wave next week to see how September typically shakes out; should be very interesting considering the historical landmines.

Tomorrow a lower open will be nearly kissing the 50 day on the S&P, so maybe a short vol, long option trade may present itself. Using Aug4/Aug 5 weekly calendars may give you a nice way to expect a bounce over the next two weeks for low risk. Or even a diagonal. A SPY 169/170 will cost you a whole 6 cents and will pay handsomely on a bounce next week.

Considering the VIX term structure highlighted yesterday, I am less apt to short vol, but it certainly could work for tomorrow or next week’s expiration. VXX put calendar for example fits this strategy. Keep in mind the structure though, the VIX is not going to fall far from here.