When the VIX spikes to 50+ and I think it will revert back to 20, what is the best way for me to get paid for the volatility? The head trader at my shop says to never short the VIX.
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As the VIX is an index, I am fairly certain you cannot short it. One would buy put options on the index.
99 times out of 100 the VIX will regress back to historical volatility ($14-$16?), and how you can profit/lose money is how sooner it returns to the normal range. Think term structure and what the market is forecasting for future volatility.
Those more experienced than me, please chime in if I am mistaken anything here.
I wouldn't buy PUTs on the VIX...
Nothing wrong with shorting vix futs if you have the capital in case you're wrong. Going long XIV is pretty dumb though.
Go long XIV after you think vol spike is over, the future roll makes it a mathematical guarantee to make money until the next vol spike
sell atm options on the SPX and hedge them
If you don't want to short VIX-based ETFs, you can buy short VIX futures which limits your downside. Alternatively , as SLIM says, you can sell the ATM SPX/SPY straddle and delta hedge. If you could continuously hedge all the way to expiry you'd get PnL proportional to the realized variance in the underlying vs whatever vol you sold. In reality hedging your deltas flat a couple of times a day is probably reasonable enough for the purposes of this trade.
Selling an ATM SPX straddle isn't the most efficient way to capture a pure volatility decline and isn't even guaranteed to make money as implied vol (VIX) comes in (delta hedging attempts to capture the difference between realized and implied volatility but only choosing a single strike drastically changes the pay off for most situations, especially during extreme market events). VIX/VXX put spreads are generally the safest and most effective method to capture pure volatility decline without trying to get too cute.
Ok, I see your point about selling a straddle causing an unpredictable payoff in the event of some non-continuous distribution in outcomes of the underlying. I'll also concede that put spread on a vol index exposes you to less extreme move risk. It does introduce skew risk into your position, though. I'm not too familiar with vol index options but I expect that could be a serious concern as well.
The question is a little ill-posed because it just says "what's the best way to capture volatility decline", when it should specify whether they are talking about IV or RV. Nevertheless, It seems to me, at least from an academic standpoint, that the best way to purely capture an opinion on a decline in vol is to sell the IV and buy the RV. I think the best way to do that is to sell the straddle and delta hedge, especially if you can hedge nearly continuously. I'm ready to be convinced otherwise, though.
Selling the IV and buying the RV? I have a feeling you don't know what you are talking about in the slightest
What I said was meant as short-hand for selling the straddle and delta hedging. The PnL you realize from that trade is the spread between IV when sold and the RV over the life of the option. Natenberg has a pretty straightforward example that walks through it step by step, I believe.
All this aside, for a retail account, it seems like the best way to express a short vol opinion is to buy a short VIX ETF.
Nah, if you just sell the straddle and delta-hedge, you're gonna have to be a bit more careful...
"Selling the IV and buying the RV" is shorthand for "selling the straddle and delta hedging"?
1) Not really a short hand by any stretch of the imagination
2) I have traded options professionally so dont need to have explained how capturing implied/realized differentials works. But I can tell you no one ever uses "selling IV and buying RV" as a shorthand for selling vol. It doesnt actually make sense and noone in finance would ever use a phrase like that. That sentence implies you want implied vols to go down (which is true) but realized vol to be higher (which is not true). If you had read Natenberg a bit more carefully maybe, you would understand that you want the differential to be as large as possible, not to converge as your "shorthand" implies.
Lol at "hedging your deltas a couple times a day"
The guy is asking for a way to put on a trade, not to moonlight as an S&P trader in the process.
Is this for your personal account? If so, delta hedging (as someone above suggested) is not realistic assuming you have a real job, especially if you work in finance and have personal trading restrictions.
If vol spikes to 50, that means stocks are getting killed. The best way to capture returns in a personal account would therefore be to buy stocks when they're cheap and vol is at 50. If vol goes back down below 20, you'll probably be making a lot of money. Of course, nobody knows when vol could spike to 50 and you'll probably miss out on a lot of gains while you're waiting for all of these perfect conditions to exist.
Forest for the trees guys....
Yep, no need to re-invent the wheel, I'd just write PUTs on dividend players.
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