This VIX Butterfly Spread Profits If VIX Is Between 30 and 50

Market volatility remains elevated as measured by the CBOE Volatility (VIX) Index. VIX is a real-time index that represents the market expectation for near-term volatility in the S&P500 index.

Investors and traders have long used VIX as a measure of the level of risk, fear or stress in the market.

Today, we’re going to look at a long call butterfly using VIX options as a way to profit if volatility continues to rise.

A long call butterfly is constructed through buying a call option, selling two higher calls and buying one call even higher.

The trade is entered for a net debit meaning the trader pays to enter the trade. This debit is also the maximum possible loss.

Usually, a butterfly is placed roughly at-the-money, but today we are looking at placing it out-of-the-money.

Using the October 19 expiry, the trade would involve buying the 30 strike call, selling two of the 40 strike calls and buying one of the 50 strike calls. 

The cost for the trade would be $125 which is the most the trade could lose. The maximum potential gain is $875, which would occur is VIX closed right at 40 at expiration. The lower breakeven price is 31.25 and the upper breakeven price is 48.75. 

There are three general outcomes with this butterfly.

• VIX below 30 – Trade loses $125. This scenario should be reasonably acceptable for most investors. While the option trade suffers a full loss, hopefully stocks have been stable or rising.
• VIX between 30 and 50 – Good for the VIX butterfly, but potentially bad for stock portfolios.
• VIX above 50 – Full loss on the VIX trade and potentially big drops in stock portfolio.

So VIX above 50 is the main scenario that hurts in this case, but how likely is that? It’s quite rare to see a VIX reading above 50 (but it does happen).

Using VIX options can be simple and cheap way to buy some protection against a sharp selloff in stocks between now and July. The trade can be placed relatively cheaply at $125 per contract. 

VIX options behave differently to regular stock options, so it is important that any trader using this product fully understands the risks involved. As always, do your own research and due diligence before risking any of your hard-earned capital.

Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

*Disclaimer: On the date of publication, Gavin McMaster did not have (either directly or indirectly) positions in some of the securities mentioned in this article. All information and data in this article is solely for informational purposes. Data as of after-hours, September 28, 2022.

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