It’s significant that Steven Sears even felt the need to write this column in the first place; it’s even more significant that he actually published it, and said today:

[A]ll it took was some bad inflation data Tuesday, and a few crummy earnings report, for the Chicago Board Options Exchange’s Market Volatility Index (VIX) to jump up about 6%, to almost 18.

If this number seems random to you, guess what? It is. Investors need to fight the temptation to view VIX as the end all, be all, in the options market. [link; our emphasis]

Indeed. While the VIX isn’t actually a random number, it certainly is just a statistic, and that means many of the traditional tools of analysis simply won’t apply. And the VIX has definitely received too much attention of late, and is being asked to perform too many roles - market timer, sentiment indicator, and even trading vehicle.

The real question now is: has the VIX jumped the shark? Try as we might, it’s getting harder and harder to find a source whose daily market commentary doesn’t feature at least a casual nod to VIX action, and more importantly, those passing references almost always describe it one-dimensionally as “the fear index.” A Google Trends analysis suggests that the VIX has become a permanent fixture in both financial journalism and among the terms for which punters like us regularly search (the attached chart is US-only; there’s some unrelated Japanese term that skews the global results). The ubiquity of the VIX is as recent as early 2008: while spikes in searches and in news coverage matched spikes in the index itself during 2007, what we’re seeing now is a fairly steady stream of stories and searches even during a market rally. This may mark a fundamental shift, in that the story used to be, “market selloff = VIX spike = people are scared!” but is now “hey, look how low the VIX is going!”

Nous sommes tous VIX-watchers.

A funny thing about calendar spreads is that, because both legs are at the same strike, it doesn’t make much difference whether the spread is constructed with puts or calls (as long as both legs use the same one). In pretty much every way—profit/loss profile, greeks, adjustments—a calendar call spread and a calendar put spread are virtually identical. So how do we decide which one to use? Generally, it’s a matter of splitting hairs.

Sometimes we’ll pick one over the other because it’s out of the money and has zero risk of assignment, at least initially. But the trades we choose have almost no assignment risk anyway, because we avoid options that don’t have a lot of premium and stocks that have an ex-dividend date between the time we open the trade and the first expiration. And, we close the trade well before expiration.

Another factor—though it, too, is usually very minor—is volatility skew. When we open a calendar spread, we don’t want to buy significantly more volatility than we’re selling. For example, if the implied volatility of the June 100 call is 25% and the IV of the July 100 call is 30%, we wouldn’t take that trade. However, if the June 100 put for the same stock is trading at an IV of 26% and the July 100 put’s IV is 28%, we’d be able to open the equivalent position without taking on excessive risk.

Hasenpfeffer, anyone?

ETFs are great for delta-neutral trades like iron condors and calendar spreads. because they buffer us from sudden, news-driven moves in any one stock. But some individual stocks are stable enough that, with the flexibility we have to adjust our calendar spreads, we can trade them without taking on an unacceptable level of risk. One stock that’s a good candidate for calendar spreads is IBM, and we’re going to use it for our third June Calendar Options trade.

The Thesis

IBM’s historic volatility for the past 12 months has stayed below 35%, and implied volatility on the options is now at a 10-month low. The next earnings date for the company is July 18, and the ex-dividend date for this quarter has passed. Moreover, July options are available, so we don’t have to take on a lot of vega risk. With 31 days to June expiration and the stock trading very close to $125, this is a nice opportunity to open a single calendar spread.

The Trade

Single-calendar adjustments sometimes require splitting the position twice, so we need at least four contracts. Here’s the trade we’re making today:

+4 IBM July 125 put
-4 IBM June 125 put
for a net debit of $1.55.

Our break-even points are at $121.50 and $128.75 on the underlying share price. With a relatively narrow profit range, single calendars very often need to be adjusted. If IBM gets too close to one of the break evens, we’ll start thinking about adjusting this into a double-calendar. But if the price stays stable, we have a good chance of locking in a 20% profit in about three weeks.

We’re making some changes to our monthly review - hopefully the structure of this new format will make it easier to follow along and compare our strategy with the relevant benchmarks. Going forward, we’ll include the following items in each monthly review: 1) a quick-glance overview of our monthly performance, in the chart at right; 2) a performance comparison of our positions for the month vs. the SPX, DJIA, and RUT, plus BEP, which is an S&P 500 Covered Call Fund. 3) more details about each of our positions, including any comments we may have; 4) links to important (non-trade) articles from the past month, in case you missed any of them.

Performance comparison

Here’s how the major market indexes, the S&P 500 Covered Call Fund (BEP), and the Condor Options trades performed over the past month:

• S&P 500: 2.52%
• Dow Jones Industrials: 1.07%
• Russell 2000: 2.78%
• S&P Covered Call Fund: 7.69%
• Condor Options: 12.62%
• Note: the period measured is from expiration to expiration, rather than from the start of the month.

May Iron Condors

• DIA 116/118/134/136: 30.46% return - This was a no-brainer; we closed out the 188 puts on principle (markets tend to crash down, not up) and let the rest expire worthless.
• DIA 113/115/130/132: (10.56%) return - We closed out this position fairly quickly as the rally gathered steam in order to reduce our overall risk. As part of a larger portfolio, it would have been easier to hold on and make an exit several days later for a small win/breakeven - some readers did just that.
• SPY 128/130/146/148: 17.96% return

May Reading

Here are some posts from the past month that are worth checking out if you didn’t catch them the first time around:

• Getting Your Fill
• Calendar Options: Five Things You Need to Know About Calendar Spreads
• Introducing Calendar Options
• How Vega Can Deceive You: Part I
• How Vega Can Deceive You: Part II
• 8 Hedging Ideas for Iron Condors, Part 1
• 8 Hedging Ideas for Iron Condors, Part 2 (Members only)

We’re already in two June positions and, if implied volatility picks up next week, may well enter two more. Hopefully this summer will be a bit more lively than usual!

With its 30-day historic volatility ranging between about 20% and 30% over the past six months, and implied volatility tending to stay above historic volatility, the Retail HOLDRS ETF (RTH) is a good candidate for a calendar spread. Implied volatility for RTH currently rests near its nine-month low. Moreover, July-expiration options are available for RTH, which means we could buy a one-month spread and avoid the higher vega that’s currently punishing our EEM June/Sept spread.

The Thesis

With 36 days until June expiration, this is a good time to open a calendar position. At this point in the cycle, we’re considering single (one strike) calendar spreads; however, single calendars are best opened at the money, and RTH is trading just about dead center between the 95 strike and the 100 strike. With economic conditions still questionable, we don’t want to be bullish and use the 100 strike, but the strength that the market has been showing is reason enough not to be too bearish and pick the 95 strike either. Therefore, we’re going to make this another double calendar.

The Trade

Were opening the following double-calendar spread on RTH:

+2 RTH July 100 call
-2 RTH June 100 call
+2 RTH July 95 put
-2 RTH June 95 put
for a net debit of $2.35.

Our break-even points are at $93.40 and $101.90. Target profit is $0.35, and our stop-loss is $0.40—but we expect to be able to adjust the trade long before getting there. As with our EEM double-calendar, we’re trading an even number of contracts to create a position that can be split if adjustment is needed.