Latest / The Day Trading Podcast with Fexingo: Active Trading, Charts, and Short-Term Market Strategy / How Day Traders Read the VIX-VVIX Convergence Trade
Transcript
- Lucas: The VIX is at 19.49 tonight, up about five and a half percent on the week. The VVIX, which is the volatility of the VIX itself — the options on the VIX — is at 99.50, up more than thirteen percent. That spread has been widening for about six trading sessions now, and I think it's setting up one of the cleaner convergence trades we've seen since the COVID crash in 2020. Luna: So the VIX goes up, the VVIX goes up faster — that makes sense during a risk-off move. But you're saying the gap itself is a signal? Lucas: Exactly. Normally the VIX and the VVIX move together — not one-for-one, but directionally correlated. When they diverge significantly, it often means the options market is pricing in a volatility spike that hasn't fully hit the spot VIX yet. But the thing is, these divergences tend to mean-revert. The VVIX can't stay elevated relative to the VIX forever, because the two are linked through the pricing of VIX options. Luna: Right, because if the VVIX is too high, you'd have arbitrageurs selling VIX options and buying VIX futures to capture the premium. That should pull the VVIX back down. Lucas: That's the theory. And in practice, it works — but the timing is tricky. Let me give you the specific numbers. On June 15, the VIX was around 17.50 and the VVIX was around 82. That put the ratio at about 4.7. Fast forward to today, the VIX is at 19.49, the VVIX at 99.50 — ratio is now about 5.1. That's a meaningful expansion in just over a week. Historically, when that ratio pushes above 5.0, it tends to revert within the next five to ten trading days. Luna: And the trigger for this divergence — was it the SpaceX IPO gamma stuff we were talking about a few episodes ago? Or the Russell 2000 rebalance? Lucas: I think it's a combination. The Russell 2000 had that gamma squeeze that pushed the index up about three percent in a week, which actually suppressed the VIX a bit — the VIX didn't rise as much as the VVIX because the equity move was concentrated in small caps. Meanwhile, the VVIX was reacting to broader tail-risk concerns — the Warsh Fed uncertainty, some geopolitical headlines — so it jumped. That created the gap. And the market is now pricing in a potential mean-reversion in the VIX itself. If the VIX catches up to the VVIX, we could see a spike to 22 or 23. If the VVIX collapses back, we'd see a drop toward 85. Luna: Before we dive deeper — and I know this is a bit meta — but we get a lot of questions about how we keep this podcast going without ads. The truth is, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds us making this many episodes. It's a small group, but it's enough to keep the lights on and keep us independent. Lucas: Yeah, and we really appreciate it. It means we don't have to sell sponsorships or push products we don't believe in. So if our conversations have helped you think about a trade or a market structure differently, that's the reason to consider it. No pressure, just letting you know how it works. Luna: Alright, back to the convergence trade. So if I'm a day trader looking at this, how do I actually execute it? Do I trade VIX futures, VIX options, or directly the SPX? Lucas: There are a few ways. The cleanest is to trade the VIX futures curve. If you think the VVIX is going to fall, you could sell VIX call options or buy VIX put options — but that's directional, and the premiums are high right now. A more nuanced approach is a relative-value trade: you sell VIX options and buy VIX futures to hedge. That captures the VVIX premium decay. But for day traders, I actually think the simpler play is to watch the SPX gamma flip. Luna: Because the VVIX spike often coincides with dealer gamma turning negative in the SPX, right? Lucas: Bingo. When dealers are short gamma, they have to sell into weakness and buy into strength, which amplifies moves. The VVIX tends to peak around those inflection points. So if you see the VVIX push above 100 and then start to stall — like it's done tonight at 99.50 — that's a signal that dealers might be covering their gamma hedges. You could then look for a reversal in the SPX. Today the S&P closed at 7,365, down about 1.9 percent on the week. If the VVIX rolls over, you might see a bounce in the S&P. Luna: So the trade would be: wait for the VVIX to show a clear rejection — maybe a bearish engulfing candle or a failed breakout above 100 — then go long SPX or buy call spreads? Lucas: That's one approach. But you need to be careful because the VIX itself is still elevated. If the VIX catches up to the VVIX instead, the S&P could sell off another 1 to 2 percent. So I'd prefer to trade the VVIX directly. For example, you could buy a VVIX put spread — say, the 100/90 put spread with maybe a week to expiration. That's a defined-risk bet that the VVIX will drop. And the theta decay works in your favor because the VVIX term structure is in contango right now — front-month options are losing value quickly. Luna: Let's talk about the term structure specifically. The VVIX futures curve — what does it look like? Lucas: It's steep. The front-month VVIX futures are around 99, the second month is around 92, the third month around 87. That backwardation — wait, no, that's contango — the curve is upward sloping? Actually, let me clarify. The VVIX itself is at 99.50, but the futures are below that — front-month at 97, second month at 93. So the futures are in backwardation relative to the spot VVIX, which is unusual. Normally the futures trade at a premium. This backwardation tells you that the market expects volatility to decline. That's actually a contrarian signal: when the curve is this steeply backwardated, it often means a volatility spike is imminent. Luna: So the VVIX futures are already pricing in a drop, but the spot is high — that's a tension. And you're saying the resolution is usually a spike in spot VIX? Lucas: Historically, yes. But not always. Sometimes the VVIX does drop sharply and the futures converge to a lower level. The key is to watch the VIX itself. If the VIX starts to break above 20, that's a sign the spike scenario is playing out. If it stays below 20 and the VVIX starts to decline, the mean-reversion is happening via the VVIX. As a day trader, you want to wait for the confirmation — a strong move in either direction — and then ride the momentum. Luna: There's also the correlation with the VVIX and the Russell 2000. The Russell is up 1.2 percent this week while the S&P is down. That divergence is unusual too. Lucas: That's the gamma flip effect we talked about in episodes 53 and 54. The Russell has been the epicenter of a gamma squeeze, and that's kept the VIX from spiking as much as the VVIX. But if the Russell rolls over, the VIX could catch up quickly. So one way to trade this convergence is to short the Russell against a long S&P position — a pairs trade that benefits from the rotation. But that's more of a swing trade for the next few days. Luna: Let's talk about risk management. If you're wrong and the VVIX keeps ripping — say, because of a geopolitical event — what's your stop? Lucas: If you're trading the VVIX put spread, your max loss is the premium paid — so it's defined. But if you're trading SPX directly, I'd use the VIX as a stop. If the VIX closes above 21, that tells you the volatility spike is accelerating, and you should get out of any long spx positions. Alternatively, you could use the VVIX itself: if it closes above 105, the divergence is still widening, and you don't want to bet on convergence yet. Luna: So the trade is really about waiting for that VVIX rejection at a round number like 100. Lucas: Exactly. And we're right at that level tonight. The VVIX touched 99.50 and stalled. Tomorrow, June 24, we could see a test of 100. If it breaks through, the divergence continues, and you stay on the sidelines. If it gets rejected — especially if the S&P holds above 7,350 — you can enter the convergence trade with a tight stop. I'd be watching the first hour of trading for a clear signal. Luna: One more thing — the VVIX open interest. Have you looked at the options concentrations? Lucas: I glanced at it. There's a large open interest at the 100 call strike in VVIX options for the June 26 expiration. That's only three days away. That strike could act as a magnet or a cap. If the VVIX stays below 100 through expiration, those calls expire worthless, and the dealers who sold them can unwind their hedges — that could actually accelerate a drop. But if it pushes above 100, there's a gamma squeeze potential on the VVIX itself, which is rare but could be explosive. Luna: So the 100 strike is the battleground. Lucas: It is. For day traders, that's the line in the sand. Below 100, you lean short volatility. Above 100, you respect the momentum and wait. It's one of those setups where patience really pays. Luna: Alright, so to recap: VIX at 19.49, VVIX at 99.50, ratio above 5, VVIX futures in backwardation — all pointing to a potential convergence. The trigger is a rejection at 100 on the VVIX. And the Russell divergence adds another layer. Lucas: That's the framework. Tomorrow's open will tell us a lot. If the VIX gaps up and the VVIX gaps down, that's the convergence happening in real time. If both gap up, the spike scenario is on. Let's see what the data shows.