Sell in May? This VIX Butterfly Spread Could be the Perfect Trading Strategy

Market volatility has fallen markedly as measured by the CBOE Volatility (VIX) Index. VIX is a real-time index that represents the market expectation for near-term volatility in the S&P500 index.

Investors and traders have long used VIX as a measure of the level of risk, fear or stress in the market.

Today, we’re going to look at a long call butterfly using VIX options as a way to profit if volatility jumps up again in the next few weeks.

A long call butterfly is constructed through buying a call option, selling two higher calls and buying one call even higher.

The trade is entered for a net debit meaning the trader pays to enter the trade. This debit is also the maximum possible loss.

Usually, a butterfly is placed roughly at-the-money, but today we are looking at placing it out-of-the-money.

Using the May 16 expiry, the trade would involve buying the 20 strike call, selling two of the 25 strike calls and buying one of the 30 strike calls. 

The cost for the trade would be around $40-45 which is the most the trade could lose. The maximum potential gain is $460, which would occur is VIX closed right at 25 at expiration. The lower breakeven price is 20.50 and the upper breakeven price is 29.50. 

There are three general outcomes with this butterfly.

• VIX below 20.50 – Trade loses $45. This scenario should be reasonably acceptable for most investors. While the option trade suffers a full loss, hopefully stocks have been stable or rising.
• VIX between 20.50 and 29.50 – Good for the VIX butterfly, but potentially bad for stock portfolios.
• VIX above 29.50 – Full loss on the VIX trade and potentially big drops in stock portfolio.

So, VIX above 30 is the main scenario that hurts in this case, but how likely is that? We’ve only seen a VIX reading of above 30 on a handful of days in the last six months.

Using VIX options can be simple and cheap way to buy some protection against a mild selloff in stocks between now and mid-May. The trade can be placed relatively cheaply at $40-45 per contract. 

VIX options behave differently to regular stock options, so it is important that any trader using this product fully understands the risks involved. As always, do your own research and due diligence before risking any of your hard-earned capital.

Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

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