If you’re a short volatility trader, you also need to think about making money when volatility goes up. Why? Because when you short volatility temporary drawdowns are inevitable as it’s anything but a smooth ride.
Shorting Volatility: Drawdowns Are Baked In
What goes up must come down, and that’s when the short vol crowd piles in and profits by betting on the return to normalcy. But as history shows the Spikes in vol are sharp and violent, while the grind back to baseline is slow and treacherous, riddled with “fake outs” and mini-reversals.
One of our studies showed even a 10% dip after a spike is most likely a fakeout.
Now, imagine offsetting these temporary drawdowns with gains from long volatility. If you’d banked profits during the vol ramp-up, those profits cushion the inevitable temporary drawdowns on the short side.
Building a Balanced Volatility Strategy
Here are Some practical approaches:
When our CI Volatility Long Vol Indicator signals a likely upcoming vol event:
Buy VIX Options: See our guide on whether buying Naked VIX Calls or Call Spreads is right for you.
Tail-Risk Protection: Use this strategy to find cheap tail hedges for your portfolio.
Selling Calls or Call Spreads on High-Beta Laggards: Start by curating a watchlist of high-beta stocks that are already underperforming relative to the broader indices.
Buying Deep Out-of-the-Money Index Puts: For outright downside insurance, allocate to far out-of-the-money puts on major indices like the S&P 500. These “lottery ticket” options carry low upfront cost but deliver massive payoffs during tail events. Remember, these puts need a meaningful decline of indices to turn profitable, so you can fund them by pairing with credits from the call sales above.