Many short term traders would like to take a stand on volatility, i.e. get long the VIX at let’s say 16 or perhaps get short the VIX at 22. But let’s face it, speculating on the direction of volatility is really no different than speculating on the direction of a stock. Traders spend hours researching the fundamentals, maybe some technical analysis, some investor sentiment, etc.They then put on the trade and watch as it goes against them.

Trying to forecast the direction of the VIX or volatility is challenging and executing a long or short in the VIX can be challenging as well. As most VIX traders know, the underlying index is simply a metric and cannot be purchased as such. Some of the ways traders can get long the VIX, for example, is through the purchase of VIX Call Options and/or purchasing the futures on the VIX. However, purchasing VIX Calls usually entails paying the premiums. VIX Futures trade at a discount or a premium to the index; and currently, the VIX Futures are in contango to the cash price presenting all kinds of headaches for the trader/investor who would like to be long and mimic the spot price. Yes, there are some tracking ETF’s and ETN’s that try to represent the index but they too, pose the same challenges as VIX Calls and VIX Futures in that these products track the index indirectly through the futures contracts.

The pseudo correlation between these products can provide professional traders with some quasi-arbitrage opportunities that exist between the ETF’s, ETN’s. futures and options. As a trader, I never seemed to get the direction of a stock right and I had just as bad of fortune when picking the direction of volatility. But by parsing through some of the aforementioned products I may be able to identify some delta-neutral or as close to delta-neutral arbitrage opportunities as possible with a trading edge.

I do not know where volatility will be trading next week, next month or next year, however; I do know that VIX Futures will converge with VIX Cash over time. Having said that, I would like to present a trade that includes the VXX vs. VIX Options. I did mention earlier that the VIX Futures are in contango and as such, I would like to sell and capture the options premiums found in the VIX Forward Months Options. For example, the VIX February Options are reflecting a VIX Futures of approximately 22. To hedge against these options I would get long VXX. The VXX has been a disaster for traders and investors alike who have been on the long side of this ETN. mostly because of the contango curve that has been in place for some time now. As a short term trade, (one day to 4 months) this particular ETN will be a suitable hedge against the VIX Options.

The VXX is an ETN that tracks the VIX based upon the weight of the first two VIX Futures months. The contango curve, the rolling expenses incurred by selling and purchasing the contracts to reflect the parallelism of the price’s first two futures months has been a drag on the ETN. However, for a spike in volatility and/or a VIX backwardation curve this is the product you would want to own.

Here is an example of a trade where I would get long VXX and short the VIX February 20 Calls:

Long VXX

Sell 3 VIX Feb20Calls @ $4