Bill Luby of VIX and More highlights two new ETFs based on VIX futures that give traders new option-trading possibilities.

Whether or not I find it useful to flog the wounded horse otherwise known as the VelocityShares Daily 2x VIX Short-Term ETN (TVIX), which has had serious tracking problems lately, it seems as if investors and the media insist that the wild and crazy story of this +2x VIX futures ETN remain on the front page for now.

While the TVIX story is indeed a fascinating one, I fear it has crowded out a potentially more useful recent development: the launch of options on two important VIX ETFs:

ProShares Ultra VIX Short-Term Futures ETF (UVXY)


Click to Enlarge

ProShares Short VIX Short-Term Futures ETF (SVXY)


Click to Enlarge

First off, note that the fact that these two products are exchange traded funds (ETFs) instead of exchange traded notes (ETNs) means that it was much easier for options to be approved. While their more famous ETN counterparts, TVIX and XIV, grab most of the headlines, the addition of options means that traders now have much more flexibility in terms of strategy and tactics with UVXY and SVXY.

In the past, when I have mentioned how options on VIX exchange traded products (ETPs) were critical to their long-term success, I was met with a few (electronic) blank stares. Part of this reflects that fact that many have been drawn to the VIX ETPs for the potential to reap huge profits in a short period of time with leveraged trades.

Talk to most professional options traders, however, and leverage is rarely a factor they mention as a reason for their focus on options trading. In fact, pros are more likely to cite the two key advantages of options as their flexibility and ability to structure defined-risk (or limited-risk) trades.

This brings me back to options on UVXY and SVXY. With UVXY down 83% for the quarter as of last week’s close, one would think that defined-risk positions—on the long or short side—would be a critical factor in structuring future trades.

With the huge contango and negative roll yield currently in the VIX futures, a directional bet in either direction entails huge risk. For shorts, this means that a short position can have its risk capped by buying UVXY calls. For longs, this means that a long position can also limit risk by buying puts.

There are other ways to implement defined-risk trades, notably with vertical credit spreads and vertical debit spreads where gains and losses are limited to the distance between strikes. Traders can also just simply buy puts and calls to put a directional idea to work, knowing that their maximum loss will be limited to the purchase price.

In hard-to-borrow situations—which are common with some VIX ETPs—traders can also use options to create a synthetic position. For instance, a long put plus a short call is the equivalent of a synthetic short, so if no shares are available to borrow, a synthetic position might be an excellent proxy with the same profit and loss potential as a standard short position, yet typically tying up a lot less trading capital.

Note that the markets for options in UVXY and SVXY are still young and not particularly liquid at this stage. On the other hand, volumes are ramping up quickly (see volume bars on the charts above) and the flexibility and risk control inherent in options products makes these attractive, particularly so when applied to highly volatile products like UVXY and SVXY.

By Bill Luby of VIX and More

Related Articles
  1. Chart Advisor

    Bumpy Roads Ahead In Transportation

    Investors are keeping an eye on the transportation industry. We'll take a look at the trend direction and how to trade it.
  2. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  3. Mutual Funds & ETFs

    3 Fixed Income ETFs in the Mining Sector

    Learn about the top three metals and mining exchange-traded funds (ETFs), and explore analyses of their characteristics and how investors can benefit from these ETFs.
  4. Chart Advisor

    Agriculture Commodities Are In The Bear's Sights

    Agriculture stocks have experienced strong moves higher over recent weeks, but chart patterns on sugar, corn and wheat are suggesting the moves could be short lived.
  5. Investing News

    Top Tips for Diversifying with Mutual Funds

    Are mutual funds becoming obsolete? If they have something to offer, which funds should you consider for diversification?
  6. Professionals

    Top Stocks to Short, Go Long On to Beat the Market

    A long/short portfolio can help weather a variety of market scenarios. Here's how to put one together.
  7. Mutual Funds & ETFs

    Top 4 Asia-Pacific ETFs

    Learn about four of the best-performing exchange-traded funds, or ETFs, that offer investors exposure to the Asia-Pacific region.
  8. Stock Analysis

    The Biggest Oil Producers in Asia

    Learn which Asian countries deliver the most crude oil to market, and discover what companies are the biggest producers in each country.
  9. Mutual Funds & ETFs

    Top 3 Japanese Bond ETFs

    Learn about the top three exchange-traded funds (ETFs) that invest in sovereign and corporate bonds issued by developed countries, including Japan.
  10. Stock Analysis

    The 5 Biggest Russian Oil Companies

    Discover the top Russian oil companies by production volume and find out more about their domestic and international business operations.
  1. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  2. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  3. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  4. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  5. Does index trading increase market vulnerability?

    The rise of index trading may increase the overall vulnerability of the stock market due to increased correlations between ... Read Full Answer >>
  6. What does a high turnover ratio signify for an investment fund?

    If an investment fund has a high turnover ratio, it indicates it replaces most or all of its holdings over a one-year period. ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!