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Home » Blog » 2020 » 02 » Another View of the $VIX/SPY Hedged Strategy (18:4&5)
By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 18, No. 4&5 on March 5, 2009. 

We have been using the hedged strategy between volatility and the broad market for over a year now, and the results have been good. But there’s more to this strategy than meets the eye. So, perhaps it isn’t useful only when $VIX futures are sporting a big premium or discount. It might make sense in a broader array of situations.

For those not familiar with the strategy (which, hopefully, are just our most recent subscribers), let’s review the basics. We always employ the strategy with the options on both $VIX and SPY. $VIX is the CBOE”s Volatility Index, and its options trade on the CBOE. SPY is the S&P 100 ETF, which represents 1/10th of the S&P 500 Index ($SPX). In general, when the stock market (SPY) moves down, volatility ($VIX) moves up, and vice versa. Thus, the hedged strategy involves taking opposite positions in these two underlyings. That means we either buy calls on both or buy puts on both. Whether we use puts or calls, we generally buy options that are at- or just slightly in-the-money. NOTE: the “underlying” for $VIX is not the index itself, but rather the futures contract underlying the $VIX options we buy – typically, the nearterm contract (so, if we buy SPY March calls, we would generally buy $VIX March calls, and the underlying is the $VIX March futures).

At current price levels and volatility levels, we have been buying an equal quantity of options on both SPY and $VIX. But a year ago, the ratio was typically 2 $VIX for 1 SPY. The ratio can be calculated at any time, if one knows a) the prices and b) the volatility of the two underlyings.

    Ratio = p1 x v1
            p2 x v2

Currently, these items are:
  SPY: 68.83 SPY 20-day Historical Vol: 38%
 /VXH9: 47.40 /VXH9 20-day Historical Vol: 60%
So, the ratio would currently be:
     68.83 x 38 = 0.92
     47.40 x 60

Since the number is close to 1, we would buy an equal number of SPY and $VIX options, provided that they both have approximately the same deltas – which they would, if both are at- or slightly in-the-money.

The “Strategy”

So, what is this position? It makes money in several different ways. Suppose we own calls on both. Then if the stock market were to stage a large rally, the SPY calls would profit by a large amount, while the $VIX calls would lose – but they can only lose the fixed amount that we originally paid for them. Conversely, if the market were to fall sharply, then $VIX would spike upwards (normally) and the $VIX calls would profit, while the SPY calls would lose – but only by the fixed amount that we originally paid for them. Hence, we can make money if a large market move occurs in either direction.

Sometimes, the hedged strategy profit potential can be enhanced, when an “edge” appears. This edge arises when the $VIX futures are trading at “too large” of a discount or premium to $VIX. If they are trading at a large premium, then we buy puts on both SPY and $VIX; if they are trading at a large discount, we buy calls. The reason for this approach is that – even if the broad stock market doesn’t move – the discount or premium in the futures will disappear, and we will make a small amount of money when that happens.


Up to this point in time, we have been employing the strategy not as a general market opinion, but only when there is an “edge.” In fact, the original creation of the strategy was merely to capture that “edge.” But when some very large market movements occurred, we were the beneficiary of those as well. The most dramatic example of that was when we were long calls on both $VIX and SPY last September and October.

If one steps back and thinks about it, this strategy should work – whether one owns calls on both or puts on both – as long as the market is volatile. Since we are currently involved in arguably the most volatile market in history (perhaps only exceeded by 1931-1933), the strategy might be employable at almost any time.

Hence one could have profited handsomely last September and October if he had been long puts on both! It didn’t have to be calls. The “edge” was with the calls and that made the initial movements profitable right away, but since SPY plunged and $VIX soared – making big profits for the SPY puts but only losing the original premium of the $VIX puts – big profits were generated. Overall, the strategy implemented with calls was slightly more profitable than the strategy implemented with puts because of the “edge,” but the largest portion of the profit came from the volatile market move.

There is a second condition to success in this general strategy, as well: it will only work as long as the general relationship between SPY and $VIX remains in effect. That is, it works as long as volatility and the stock market move in opposite directions at roughly the same speed. Without this component, the hedge doesn’t work.

Recently, the market has fallen sharply, but $VIX didn’t really increase much. Therefore, the strategy as implemented with puts would have worked just fine. But the strategy implemented with calls did not (the gain on $VIX calls was small and the SPY calls obviously lost nearly all their value). But, even in this uncommon situation, the loss was small.

Does this mean that we should be more concerned with setting up the hedge based on our market opinion than on the “edge” that exists? To do so would go against all my instincts as an arbitrageur and volatility trader. However, this current stock market has forced traders to throw out a lot of “conventional” wisdom, replacing it with more pragmatic approaches. Thus, I’m willing to consider the principle that the strategy will work better in one direction than the other – despite the “edge” that might exist.

Wednesday’s big upward move in the stock market (March 4th) worked very well with puts on both sides (that is the position that we held in Daily Volume Alerts – having worked into it in the last two days, as the market fell sharply). But calls on both sides would have worked as well.


The point is that this hedged strategy can be utilized at any time, not just when there is an “edge.” If you hold a position in SPY calls, and don’t necessarily want to jettison it if you expect a counter-trend move, then buying a matching position in $VIX options will protect you if that counter-trend move occurs, and won’t really hurt you if it doesn’t.


This article was originally published in The Option Strategist Newsletter Volume 18, No. 4&5 on March 5, 2009.  

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