Black Swan Insurance

This week I wrote an article for Seeking Alpha which describes an option portfolio that bets on VIX moving higher as uncertainty grows over the looming fiscal cliff.  The best part of the deal is that the options will make about a 50% gain even if VIX doesn’t go up a bit over the next three weeks until the options expire.
Please read this important article as it could show you a way to provide extremely good protection against you other investments should the market take a big dive this month.

Black Swan Insurance
Here’s the link:

Black Swan Insurance That Might Pay Off Even If There Is No Crash

This is a very simple strategy that involvBlack Swan Insurance That Might Pay Off Even If There Is No Crashes buying in-the-money Dec-12 13 calls and selling a smaller number of Dec-12 16 calls.  You are setting up a vertical spread for some of the calls and holding several calls uncovered long.  The 13 calls have essentially no time premium in them and the 16 calls have a lot of time premium since they are very close to the money.

The only scenario where these positions lose money is if VIX falls much below 15 when the options expire on December 19.  For its entire history, VIX has traded below 15 on only a few rare occasions, and it always moved higher shortly thereafter.

If VIX does get down close to 15 as expiration nears, additional calls might be sold against the uncovered long calls you own, maybe at the 15 strike..  This would expand the downside break-even range about a half a dollar.

There are a few things that you should know about trading VIX options. Weekly options are not available.  You are restricted to the regular monthly option series.  Even more restricting, calendar spreads and diagonal spreads are not allowed in VIX options because the underlying entity is a derivative rather than an actual stock.  You are pretty much restricted to vertical or back spreads unless you want to post a large maintenance requirement.

In spite of these limitations, VIX options are a lot better than VXX if you want to buy portfolio insurance.  VXX suffers from contango dilution most of the time while VIX fluctuates independent of any such headwinds.