The year 2025 begins with an unusual market situation: a low VIX and an overvalued US equity market raise questions about stability and possible market movements. Although no one can predict the exact timing of a correction, historical data shows that the first quarter is often characterized by an increase in volatility.
In this article, we look at how options traders can prepare for this phase. With well thought-out hedging strategies that target the VIX - such as short puts or bull call spreads - you can not only hedge risks, but also take advantage of opportunities for moderate profits. Instead of speculating on extreme scenarios such as a VIX of 60, the focus is on practical approaches that target realistic market movements. In this blog post, Alexander Eichhorn shows which VIX strategies he currently considers profitable.
Have the markets run hot?
In 2024, the S&P 500 recorded an impressive performance with an increase of almost 24 %. The current gap between the S&P 500 and its 200-week EMA is around 23 %, which is exceptionally high from a historical perspective.
The S&P 500 has staged an impressive rally over the past year, but it may be showing signs of overheating. Nevertheless, it is important to note that bull markets can often last for long periods of time and market sentiment can remain greedy for a long time. We therefore consider a purely passive wait-and-see approach for a correction or a crash to be of little use. Instead, we expect a moderate increase in volatility in the first quarter. The combination trades presented below can also be used to benefit from stable volatility, creating additional opportunities.
VIX rise in the first quarter?
There is no question that the US equity market is currently highly valued. However, the timing of a possible correction is uncertain and could be delayed for weeks or even months. For this reason, we believe it makes little sense to blindly short the stock market.
Instead, we prefer to use diversified hedging trades on the VIXas this statistically indicates an imminent rise. Historically, the VIX has regularly shown values of over 20 between January and March in recent years. The only exception was 2017, when the VIX was at 13.22 - a phase characterized by the so-called "Fed put", which was characterized by the US Federal Reserve's hedging measures.
Given the current low level of the VIX and a possible increase in the first quarter of 2025, we currently see promising opportunities for lucrative VIX trades. These strategies could prove effective in making the most of potential volatility swings.
Hedging strategies - examples
Short put strategies on the VIX index should be used with particular caution by options traders, as the puts sold can quickly run into the money if the VIX has a pronounced contango curve. Nevertheless, taking into account appropriate risk management, they offer interesting approaches for a hedging trade on a potential increase in volatility in the first quarter.
An example of suitable short puts could be the following VIX options be:
- VIX Index Options
- Term February
- Strike 18 put
- Premium approx. $ 200
- Breakeven 16.00 on the VIX
Another alternative would be the 17 short put. The further out-of-the-money options are chosen, the more the premium decreases, but at the same time also the potential risk.
Short put combined with bull call spread
Alternatively, various combination strategies on the VIX can be used to trade potential increases in volatility in a targeted manner. One effective option is the combination of a short put and an in-the-money (ITM) Bull Call Spread.
This strategy allows you to benefit from a moderate increase in the VIX while limiting risk. The short put generates premium income, while the bull call spread provides leverage on potential gains in the event of rising volatility. This combination is particularly suitable for scenarios with low entry prices and an increased upside risk of the VIX.
Example:
- VIX Index Options
- Term February
- Short put 17s
- Long Call 13s
- Short Call 30s
- Breakeven at 16.56 on the VIX. But double loss potential due to short put and long call!
- Possible profit: approx. $ 1,300 per spread (with VIX greater than 30)
At a VIX value of around 16.56, the spread begins to lose its attractiveness, and at a value below 13, two problems arise at once: The 17 short put runs into the money, while the 13 long call expires worthless. In contrast to a pure short put, however, this strategy offers a profit opportunity of around $1,300 if the VIX rises above 30.
PODCAST Tip: Our best trade ideas for the start of the year
Both the short put and the spread combination have an extremely low volatility level with breakeven points around 16. We prefer such trade ideas in order to bet on a rise in the VIX towards 20 instead of simply buying an OTM long call and speculating on a sharp rise in the VIX towards 60.
Conclusion - start of the year for options traders
A low VIX and an overvalued US equity market create an exciting starting point at the beginning of 2025. Even if the exact timing of a possible market correction is difficult to predict, historical statistics show a clear trend: an increase in volatility is often observed in the first quarter.
The presented hedging strategies on the VIX - such as short puts or the combination of short put and bull call spread - offer options traders the opportunity to profit from a moderate increase in volatility without having to rely on extreme scenarios such as a VIX of 60.
With these trades, traders can not only hedge risks in a targeted manner, but also react effectively to expected market movements that could shape the start of the year. As always, discipline coupled with a clear trading plan is the key to operating successfully even in phases of increased volatility.
