VIX Today: How To Set Up A Call Option Ladder To Protect Your Portfolio

With volatility in the stock market today at the lowest levels for two months, it might be an excellent time to think about portfolio protection. After all, the next stock market correction could be just around the corner. Could the VIX today offer a defense strategy?

Traders with a large bullish exposure in the portfolio may want to consider adding some protection with an options strategy involving the Cboe Market Volatility Index, nicknamed the VIX. One way to do that: Consider an options trade known as a ladder.

So, let's look at an example using VIX call options.

To set up a call ladder, we sell an at-the-money call option. Then buy an out-of-the-money call and another further out-of-the-money call. Out of the money means the strike price is above where VIX is trading now.

We receive a credit from selling the at-the-money call and pay debits for the two out-of-the-money call purchases.

The goal? Place the trade zero cost, or at worst, a small debit.

Using calls with a Dec. 21 expiration, that might look something like this:

Beyond VIX Today: More IBD Psychological Market Indicators

On Nov. 15, the VIX traded as high as 26.22 and closed at 24.54. So, assuming that this index traded around that level, we would receive $230 for selling the 240-strike call and pay $160 for buying the 30 and 35 strike calls.

Therefore, the trade in the VIX today meets the criteria of being placed for a credit of $70 per options contract.

This trade will give some protection in the event of a large spike in volatility in the coming weeks.

I would typically hold this hedge trade for around two weeks and then close it out if it is no longer needed.

Options in the VIX today behave slightly differently from stock options, so make sure you understand how they work before risking any capital.

Please remember that options are risky, and investors can lose 100% of their investment.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ