How To Immediately Improve Your Options Trading

Most people fail at the basics of trading options

In the fast-paced world of financial markets, options trading has gained tremendous popularity. The allure of potentially significant profits is undeniable, but the harsh reality is that many traders end up losing money due to a variety of factors. While trading options inherently involves risk, one of the major culprits behind losses is often the choice of a subpar trading platform. In this article, we'll delve into why selecting the right trading platform matters and how making the switch to Options AI can be a game-changer for your options trading journey.

Understanding the Importance of a Good Trading Platform

Why does your choice of trading platform play such a pivotal role in your trading success? A trading platform is where you analyze market data and manage your portfolio. A bad platform can lead to misunderstandings, confusion, and ultimately poor decision-making, leading to losses.

Visualize and Mitigate Risks with Options AI

Options AI understands that effective options trading requires clear visualization and risk assessment. One of the standout features of Options AI is its ability to help users visualize trades and comprehend the inherent risks. Through intuitive tools and visual representations, traders can gain a clearer understanding of how their chosen options positions may perform under various market scenarios. This empowers traders to make informed decisions and manage their risk exposure more effectively.

Highlighting the True Costs with Options AI

The Options AI platform goes beyond superficial option costs by providing insights into how much of a price move is already factored into the option premium. This transparency is essential because it helps traders assess whether an option is overpriced or underpriced relative to the expected market movement. Armed with this knowledge, traders can fine-tune their strategies and make more accurate predictions.

Beyond the Basics: Strategies and Expertise

Options AI distinguishes itself by catering to a diverse array of strategies that go beyond simple call and put buying. The platform is designed to generate trading strategies which offering a broader range of probabilities and profitability. Whether you're interested in spreads, straddles, or iron condors, Options AI provides the framework to explore and execute these strategies with confidence.

Awards Speak Louder Than Words

Recognition from industry experts speaks volumes about a trading platform's quality. Options AI proudly took home the title of "Best Brokerage for Options Trading" at the Benzinga FinTech Awards in 2022. This accolade underscores the platform's excellence in empowering traders to navigate the intricate world of options with precision.

Final Thoughts

The path to success in options trading hinges on the right tools and the right platform. By switching to Options AI, you're gaining a comprehensive solution that facilitates better visualization, risk assessment, and strategy of your trade ideas. Options trading is inherently challenging, but with the right platform like Options AI, you can significantly increase your chances of turning the tide in your favor. It's time to take your options trading journey to the next level.

You can use this link to obtain a special promotion of a free moth of trading on their platform.

The Fatal Flaws of VXUP and VXDN

Today's post is a follow up to last week's post, "Details on New VIX ETFs: How VXUP and VXDN Work." In hindsight, the title should have included the words "in theory" because the reality of how these funds work is drastically different. The funds are subject to strong arbitrage pressures from VIX futures and will constantly be trading at a premium or discount to the funds' theoretical price, known as Net Asset Value, or NAV (also sometimes referred to as the fund's "Intrinsic Value").

In real trading, the major problem with the concept of these new funds is the presence of a VIX futures term structure that can range +/-20% at times. When AccuShares announced the launch of an ETF that tracks spot VIX, everyone immediately looked forward to getting in on the arbitrage trade to be long VIX and short front month VIX futures during contango. After all, spot VIX and futures converge each month and this trade is essentially free money. The reason for the price difference between spot VIX and futures stems from the principle that VIX is mean reverting. This generally keeps the price of VIX futures higher than spot VIX when VIX is lower than ~20 (the long term average) and VIX futures lower than VIX when VIX is above ~20.

We saw this arbitrage gap close quickly in the first day of trading of VXUP and VXDN. VIX was +0.94% on May 19, while $VXUP was +10.56% and $VXDN was -10.56%. That's not at all tracking towards spot VIX. That is adjusting toward June VIX futures. Such behaviour to price in known information can be expected in a free market when there are obvious pricing discrepancies in what are essentially identical products.

June VIX futures settle on June 17, which is only two days away from the VXUP/VXDN Distribution Day on June 15. Given that the objective of VXUP & VXDN is to track the monthly change in spot VIX (plus an adjustment for the "Daily Amount"), the funds immediately move toward the expected value of VIX on June 15 -- the fair value of which is already agreed upon by market participants by the price of June VIX futures.

There is nothing unique to the month of June that causes these funds to suddenly track at a wide premium and discount to NAV. In fact, the funds will stray from NAV on almost every day in order to account for the value of VIX futures. Generally, the stronger the degree of contango or backwardation the larger the premium or discount to NAV.

It seems that AccuShares (the funds' sponsor) understands these forces, hence the reason for an arbitrary 0.15% "Daily Amount" which is subtracted from VXUP and added to VXDN when VIX is below 30 (another arbitrary threshold). This 4.5% roll yield that was built into the fund operation attempts to mitigate the effects of the contango roll yield. When the VIX futures curve is greater than a 4.5% contango, the only logical purchase is VXUP, leaving no one to buy VXDN.

Using yesterday as an example, an investor looking for protection can either buy June VIX futures at 14.85, or purchase VXUP at a price reflecting a spot VIX of 12.73. If VIX rises to 14.85 by June 17th, the buyer of VIX futures broke even while the purchaser of VXUP gained 11.2% (15.7% minus the Daily Amount of 4.5%). Arbitrageurs are well aware of this and will keep the price of VXUP and VXDN away from their NAV in an amount that reflects the degree of contango or backwardation in VIX futures. VXUP and VXDN will trade at values which close the arbitrage gap, not at NAV.

Today is May 20 and is the second day that VXUP and VXDN have traded. As of yesterday VXUP traded at a 9.69% premium to NAV (which can be tracked here). Today that premium is over 10%. Given that a "Corrective Distribution" is triggered whenever the funds are at a premium/discount of over 10% for three consecutive days it is possible that we'll see triggers often. However, a Corrective Distribution trigger only helps to bring the NAV premium closer to zero as Distribution Day approaches. This does not keep the funds trading near NAV after Distribution Day since the arbitrage gap to VIX futures does not go away.

I had previously thought that the premium/discount to NAV might diminish as the next Distribution Date approached, but it is clear now that if that were the case there would be an immediate and large gap on the following morning, just as we saw on the first day of trading in VXUP and VXDN yesterday. Instead, I expect the premium or discount to be persistently present, depending on the degree of contango or backwardation in VIX futures.

I don't expect the daily movement of these products to track as advertised. I also expect Corrective Distributions to be common as the funds stray 10% away from NAV. This will make the predictability of these funds incredibly difficult for anyone who has not built an arbitrage model.

When it comes down to it, one phrase at the top of the fund's Factsheet sums it up best: "shares of the Fund are intended for sophisticated, professional and institutional investors."

Details on New VIX ETFs: How VXUP and VXDN Work

Edit 5/21/2015: A follow up article, "The Fatal Flaws of VXUP and VXDN" has been posted.
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On Tuesday next week we will see a new pair of VIX ETFs hit the market: VXUP and VXDN from AccuShares Management. Unlike existing VIX ETPs which move based on VIX futures, these new ETFs will move based on the price of spot VIX.

However, the operation of these funds is not as straight forward as one might expect. I've gone through the 150 page prospectus and have briefly outlined what you can expect from these new products (the full prospectus is available here for those interested in additional details).

Summary

• The Up Class Shares (VXUP) and Down Class Shares (VXDN) are designed to track changes in the price volatility of the S&P 500® Index on a monthly basis.
• The Underlying Index of the Fund is the CBOE Volatility Index (VIX)
• Investors who expect the VIX Index to increase should consider purchasing Up Class Shares (VXUP)
• Investors who expect the VIX Index to decrease should consider purchasing the Down Clas: s Shares (VXDN).

Basic Fund Operation

• The operation of the funds centers on "Distribution Periods" which are marked by "Distribution Dates" (the 15th of each month).
• The primary change in value of the funds is based on the "Share Index Factor", which is reset on each Distribution Date. The Share Index Factor defines how much VXUP and VXDN move for every VIX movement.  
• --> Example: If VXUP is $25 (after distribution) on the Distribution Date, and VIX is at 20, each 1 point (5%) move in VIX is worth $1.25 (5%) to VXUP for the next month.
• Additionally, when the VIX is 30 or less, a "Daily Amount" of 0.15% ($0.0375 in this example) will be deducted from VXUP per day and will be added to VXDN.

Distributions
A primary concept of the funds are periodic Distributions. These will be predominantly done in cash for the first six months, but will be in the form of issuing paired shares of VXUP and VXDN thereafter (depending on the fund's liquidity). Here are the Distribution types:

1. Regular Distributions: Occur on the 15th of each month (the "Distribution Date").
• VXUP will be entitled to a distribution when the VIX has increased between Regular Distributions, or by 75% (“Special Distributions”).
• VXDN will be entitled to a distribution when the VIX has decreased between Regular Distributions, or by 75% (“Special Distributions”).
• --> Exception: Both share classes subject to a maximum of 90% in either direction for a single Measuring period.
2. Special Distributions: Occurs if change in VIX is +/-75% since last Distribution Date. The Shared Index Factor is also reset.
3. Corrective Distributions: Following the expiration of 90 calendar days following the inception of the Fund’s operations, if the closing trading prices of the shares of the Fund deviate from their Class Value per Share by ten percent over three consecutive business days, the Fund will make a Corrective Distribution in addition to a Regular Distribution or Special Distribution on the next scheduled Regular Distribution Date or Special Distribution Date if previously triggered.
4. Other distributions may result from reverse share splits.

Any distributions of cash, or cash and shares, will reduce your exposure and opportunity for gains arising from changes in the Fund’s Underlying Index in subsequent periods. You will need to rebalance/buy additional shares to maintain desired exposure. This concept will be made clear in the example below.

Price Movement Examples:
VXUP will often face a headwind caused by the "Daily Amount" of 0.15%. The table below summarizes the value of VXUP and VXDN for various VIX scenarios after a Measuring Period. Note that when the VIX is +4.5%, the gains in VXUP are offset by the losses from the Daily Amount (since 0.15*30 = 4.5).

In the next table, the VIX is assumed to have moved up 10% from 20 to 22 over 30 days. At the Distribution Date, the result is a 5.5% increase for VXUP and a 5.5% decrease for VXDN based on the combination of the VIX movement and the $0.0375 Daily Amount.

Note that the Fund will distribute a cash amount of $2,750.00 per 1,000 shares of VXUP. The new per share value for each fund is then set at $23.6250.

If instead there is a 10% decrease in VIX from 20 to 18 over 30 days we will have the following:

Here, VXUP will return -14.5% and VXDN will return a total of +14.5% based on both change in the VIX and the effects of the Daily Amount.

It is critical to note that after each favorable movement in a security held, your exposure is reduced due to distributions. In the case of issuing paired shares in lieu of cash, your exposure is still reduced and you would need to sell/buy shares as necessary to maintain a desired exposure.


It is worth highlighting that the Daily Amount only exists when VIX is below 30. When above 30 it is zero so the VXUP headwind goes away.


Supply & Demand and the Arbitrage Mechanism for creation/redemption of share units

• As the Fund’s shares trade intraday, their market prices will fluctuate due to simple supply and demand. 
• An arbitrage mechanism helps to minimize the difference between the trading price of a share of the Fund and its Class Value per Share. Over time, these buying and selling pressures should balance out, and a share’s market trading price is expected to remain at a level close to its Class Value per Share. The arbitrage mechanism provided by the creation and redemption process is designed, and required, in order to maintain the relationship between the market trading price of shares and their Class Values per Share between Distribution Dates.

The facts outlined above cover the basics of these new funds. There are many other additional details and nuances covered in the prospectus which I encourage you to read through if you are considering trading these products.

Bonus: Below I've included some additional risk factors contained within the prospectus that I found to be of interest.

• By purchasing VXUP, investors should have an expectation that the Underlying Index will increase during the period between Distribution Dates. If the VIX decreases during the time between Distribution Dates, investors in VXUP will experience a significant loss and could lose their entire investment.

• The Fund’s Eligible Assets are not managed to provide a maximum long-term return and even a share class experiencing a favorable Underlying Index change can experience losses if the Fund’s aggregate Class Values decline significantly. If the Fund’s aggregate Class Values decline to zero, the Fund’s Up Shares and Down Shares will lose all value, causing a total loss to all Fund investors.

• The Sponsor Has No Experience Managing Investment Vehicles. The Sponsor is recently formed, and has not previously managed any investment vehicles. There can be no assurance that the past experience of the Sponsor’s management team will be sufficient to successfully operate the Fund.

Addition of VSTOXX Futures Data Page

To help bring greater visibility into the volatility landscape in Europe's stock market, we have added a page dedicated to VSTOXX Futures.

The VSTOXX index is the 30-day volatility index for the Euro STOXX-50 index, Europe's leading blue-chip index which provides a representation of the major sectors across 18 European countries.

Similar to our VIX Futures page, the VSTOXX Futures page contains quotes, historical volatility data, key metrics, and graphs that are useful in tracking volatility.

BlackRock Confirms: Volatility Is A Valuable Asset Class

While not necessarily news to those who have been in on the volatility game for a while, BlackRock's decree to the world that volatility is an asset class should open more investor's eyes to this excellent trading vehicle.

BlackRock, which manages $3+ Trillion in assets, specifically prefers to sell equity volatility -- a common theme here at Trading Volatility as well as with many others who have come to love shorting VXX, UVXY or being long XIV and ZIV over the past few years.

A couple quotes via the Forbes article:
"Volatility is an asset class that can be harnessed to increase returns and reduce risk, according to the firm. BlackRock favors selling volatility via futures on the CBOE Volatility Index (VIX), puts on the Standard & Poor's 500 index and other securities, and variance swaps. These short volatility strategies are integrated into the equity allocations of investment portfolios."

"Selling volatility on a broad equity index has a positive expected return premium over time, as the seller effectively provides insurance to the buyer of volatility"

Adverse Effects of ETPs Which Replicate Daily Returns of an Index

Happy New Year!

Before I get to VIX topics, today we kick off 2013 with passage of the "American Taxpayer Relief Act of 2012" which maintains the current income tax rate structure except for individuals making more than $400k/year. Somewhat counter to the name of the bill, everyone will see their taxes rise as payroll taxes increase revert back to 6.2% from 4.2% and additional taxes are withheld to fund the Affordable Care Act (AKA Obamacare).   You can read the entire text of the bill here.

All in all, the bill's provisions closed the U.S.'s $1,089 Billion annual deficit by $62B and taxes are still going up for all Americans. It increases the chances for a U.S. credit ratings downgrade in the next couple months and will create a slight drag on GDP for 2013.

While I was enjoying some vacation over the past couple of weeks the markets experienced a 27% round trip move in VIX, moving from 17.84 to 22.72 and back (now at 15.31 as I write this).  Volatility ETPs have been choppy since I made my exit from XIV on 12/11. Remember that these ETPs return the daily change of an underlying index. The adverse effects of ETPs which replicate daily performance returns of an index in a choppy market are apparent over this period:

• VXX (short-term VIX futures): -0.35%
• UVXY (2x short-term VIX futures): -8.3%.
• XIV (inverse short-term VIX futures):  -7.4% 

Conditions for trading VIX ETPs remain a bit rough at this time. Stay tuned for VIX trades as the day and year unfold.

Initial Post

Today I am launching a blog in which I will discuss trading of Volatility (VIX) Futures through various ETFs and ETNs. Additionally I will be disclose my trades in this area, primarily for historical documentation purposes.

I have spent two years assembling data and completing quantitative analysis and modeling in order to build strategies for trading short-dated (1st and 2nd month) volatility futures. These strategies have substantially out-performed the standard market benchmarks and my goal with this blog is to share my experience.

Yesterday I received a signal to exit a trade in XIV (VelocityShares Daily Inverse VIX Short Term ETN) that I opened on Nov 12, 2012.   Entry price was $16.65 and the exit price yesterday was $19.61, for a
17.8% gain.  At this time there is no trade in place until we see the next market signal.


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DISCLAIMER: I am not a licensed investment adviser. Trading of securities, options and futures may not be suitable for all individuals and involves the risk of losing part or all of your money.  It is important to do your own analysis and accept full responsibility for any investment decisions you make. All content on this site is provided for informational and entertainment purposes only and is not intended as advice to buy or sell any securities. No content on this site can be used for commercial purposes without the prior written permission of the author. Copyright © 2012-2013 Jay Wolberg. All rights reserved.

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