Latest / The Day Trading Podcast with Fexingo: Active Trading, Charts, and Short-Term Market Strategy / How Day Traders Use the Volatility Risk Premium Trade
Transcript
- Lucas: So the VIX is sitting at 20.30 this morning, up over 10 percent in the last five days. And the VVIX, which tracks the volatility of VIX options themselves, is at 91.72. That spread — the gap between implied volatility on the S&P 500 and the implied vol on VIX options — is where a specific trade lives. Luna: You're talking about the volatility risk premium trade, right? Selling high implied vol on SPX options and hedging with VIX calls or something similar? Lucas: Exactly. The core idea is that implied volatility on index options tends to overstate future realized volatility. That's the volatility risk premium — traders who sell that premium collect theta while accepting the risk of a tail event. Today, with the VIX elevated but not screaming, the premium is juicy. Luna: What's a concrete way to put this on? I know there are a few common structures. Lucas: One classic is the short put spread on SPX — sell an out-of-the-money put, buy a further OTM put to cap tail risk. You collect net credit, and if the market stays above your short strike, you keep it all. The key is picking strikes where the implied volatility term structure is steepest. Right now, the front-month VIX futures are at 19.8, so spot at 20.3 isn't too far off — but the VIX term structure is in contango, which favors short vol positions. Luna: So you're selling premium in a contango environment. That's been a winning trade for a while, but we've seen how quickly it can blow up — February 2018, March 2020. How do you size it so you don't get wrecked? Lucas: Position sizing is everything. Most retail traders undercapitalize and overleverage. A reasonable approach is to risk no more than 1 to 2 percent of your account on any single vol trade. And you want the hedge — the long put — to be wide enough that if the market gaps down 5 percent, you're not facing a margin call. I've seen traders use a 10-point wide put spread on SPX, selling the 5400 put and buying the 5300 put, for a credit of maybe 2.50. That's a 25 percent return on risk if it expires worthless, but a defined loss of 7.50 if SPX tanks below 5300. Luna: And how does the VVIX come into play? You mentioned it's at 91.72 — up about 4.7 percent in five days. Lucas: The VVIX tells you how expensive it is to hedge your vol trade. If you're short SPX vol, you might buy VIX calls as a hedge. When VVIX is elevated, those VIX calls are pricier, which eats into your premium. So the spread between VIX and VVIX matters. Right now, VIX is 20.3, VVIX is 91.7 — that ratio is about 4.5. Historically, when that ratio gets above 5, VIX is cheap relative to VVIX, and short vol trades are less attractive. Below 4, VIX is expensive relative to VVIX, and selling premium is more compelling. Luna: So we're in kind of a middle ground — not screaming cheap, not screaming expensive. But still worth doing if you're disciplined. Lucas: Right. And the other piece is the macro backdrop. Alan Greenspan passed away this week at 100. He was Fed chair during the 1987 crash, the dot-com bubble, the early 2000s. His legacy includes the Greenspan put — the idea that the Fed would rescue markets. That mentality influenced a generation of traders who sold vol aggressively, thinking the Fed always had their back. Luna: Do you think that mindset is still alive today? We've had Kevin Warsh at the Fed now for a few months — he's been pretty hawkish, unwinding some of the pandemic accommodation. Lucas: It's more nuanced. Warsh wrote an op-ed in 2023 arguing that the Fed shouldn't rescue markets from their own risk-taking. So the Greenspan put is weaker. But the volatility risk premium trade isn't about relying on the Fed — it's about capturing the structural tendency for implied vol to be too high. Even without a put, the premium exists because options are bought for hedging, not speculation. Luna: That's a good point. And speaking of things that keep the show going — a couple of dollars a month is genuinely what keeps these episodes ad-free. If you've gotten something out of these vol discussions, buy me a coffee dot com slash fexingo makes a real difference. Lucas: Yeah, it's true. No big ask — just that listener support is what lets us keep digging into trades like this without sponsors dictating the content. Luna: Exactly. So back to the mechanics — how do you decide whether to use SPX or SPY for the vol premium trade? Lucas: SPX options are cash-settled and European-style, so no early exercise risk. They're more efficient for large accounts. SPY options are American-style and can be exercised early, but they're more accessible for smaller accounts. The bid-ask spreads on SPX are tighter, which matters when you're trading vol. I'd say if your account is under $100,000, use SPY. Above that, SPX gives you better execution. Luna: And what about the timing? Do you put these on at a specific time of day or day of week? Lucas: Theta decay accelerates in the last 30 days to expiration. So selling 30- to 45-day options captures the fastest decay. A lot of traders put on the trade on Monday mornings, when implied vol tends to be elevated from weekend uncertainty. By Friday, that premium often decays faster as the weekend risk is gone. Luna: So let's say I sell a 30-day put spread on SPX this morning. What's my exit plan? Do I hold to expiration? Lucas: You can, but professional traders often take profits at 50 percent of max gain. That reduces the risk of holding through a sudden spike. And if the market moves against you and the spread goes from a 2.50 credit to, say, a 5.00 debit, you might want to manage early. The key is having a stop-loss based on the P&L, not on the underlying price. Luna: What about VIX itself? Could you just sell VIX futures instead of SPX options? Lucas: Selling VIX futures is a pure short vol play, but it's less capital-efficient. VIX futures are in contango, so you get roll yield, but the margin requirements can be high. Plus, VIX futures can gap up 50 percent in a day. Most retail traders are better off with SPX put spreads. Luna: And the VVIX level — 91.7 — does that suggest any specific trade on VIX options themselves? Lucas: You could sell a VIX call spread if you think VVIX will mean-revert. Sell the 25 call, buy the 30 call, collect premium. But VIX options are tricky — they're priced off VIX futures, and the term structure can shift quickly. I'd only recommend that for traders who really understand VIX settlement. Luna: So the bread and butter remains the SPX put spread. What's your take on the current environment for that trade given the S&P at 7,473, down 1.1 percent in five days? Lucas: A 1 percent decline in a week isn't a crash. But the VIX jumping 10 percent suggests options market makers are pricing in more tail risk. That means the premium you collect is higher than it was two weeks ago. So the risk-reward is actually better now — you get paid more for the same level of risk. The question is whether the selloff continues. If we're in a correction, short vol gets harder. But if it's a normal pullback, selling premium into fear works. Luna: And how do you gauge whether it's just a pullback versus something bigger? Are you watching any specific indicators? Lucas: I look at the VIX term structure. If front-month VIX is above second-month, that's backwardation — a sign of immediate stress. Right now, front-month is 20.3, second-month is 19.8, so we're in slight contango. That's normal. If that flips, I'd be more cautious. Also, the VVIX rising faster than VIX can signal that hedgers are piling into VIX options, which sometimes precedes a bigger move. Luna: So current VVIX up 4.7 percent, VIX up 10 percent — VIX rose more, so the ratio actually compressed a bit. That might be a mild positive for short vol. Lucas: Exactly. The vix vvix ratio moved from about 4.1 last week to 4.5 today. That's a bit more favorable for selling SPX vol. Not screaming, but definitely worth a look. Luna: One last thing — how do you handle earnings season? This trade can get destroyed if a big company like Apple or NVIDIA misses and drags the whole market down. Lucas: I avoid putting on new vol trades during the two weeks around major earnings from megacaps. The idiosyncratic risk is too high. Instead, I close existing positions before those events or reduce size. It's not worth the tail risk. After earnings, if the market settles, I re-enter. Luna: Good rule. So for today, with no major earnings on the calendar, and the VIX at 20, it's a reasonable environment for a carefully sized short vol position. Lucas: Right. Just remember: the volatility risk premium is a persistent edge, but it's not a sure thing. Position size, hedge, and have an exit plan. That's how you stay in the game long enough for the edge to compound.