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Wednesday, April 10, 2013

VIX is Undervalued.

The S&P500 Index is moving into record highs and is showing very bullish action.  No way to say how high the equity market could go.  However, based on our proprietary volatility indicators, the momentum of realized volatility on the S&P500 Index is rising.  The S&P500 Index is also moving at a 13.55 realized volatility, while VIX currently is at 12.80.

The realized volatility indicator shows what an appropriate ATM IV of May options could be.  Since VIX on average has 12% premium over ATM IV levels, fair value of VIX should be around 15, regardless of whether the index is moving up or down.

The May VIX futures is trading now at 14.60, naturally at a premium over VIX, but 14% premium is also lower than the 18% premium on average, VIX futures trade with over 5-weeks to go before its expiration.

Executing a ratio call spread, selling the VXX May 19 call and buying 2x VXX May 21 call for under 0.40 debit wold be a good risk/reward strategy and gives you exposure to volatility over the next 2 weeks through big chunk of earnings season without too much risk.

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