Unlike TVIX, UVXY and VXX are optionable and thus raise the question for the short vol club: Is it better to short shares directly or to take a less direct short position by selling calls?

Personal preference will dictate the answer, but for my trading, I’ve been able to surmount the disadvantages of selling calls when compared to shorting shares:

  • As a seller of options, you have no control over whether and when you might get assigned. But then, if you get assigned, you’re basically just in the same position as someone who shorted 100 shares… and unlike the person who simply shorted the shares, you were paid to do it (when you collected the premium payment for the option sale).
  • There’s a possibility (and it’s a strong possibility if you sold deep-out-of-the-money options) that you won’t actually end up taking a short position in the shares. But then, that doesn’t bother me at all since I was paid a premium payment for the option sale (so I’m still profitable on the trade).
  • If you want to take a short position on fewer than 100 shares, then selling options isn’t the way to go. Personally, as an option seller this doesn’t bother me, as I’ve grown accustomed to thinking in terms of trading 100-share lots.
  • Directly short-selling shares is a position that can be held in perpetuity, at least in theory. But then, long-term positions can be held with LEAPs (long-term options), or one can just make short-term and/or medium-term option trades on a regular basis.

So yes, there are advantages of shorting shares over selling options, but personally I don’t find them particularly compelling. Of course, you have to decide which methods and strategies are best for your own situation.

The advantages of selling calls over shorting shares are quite strong, in my opinion:

  • You collect a premium payment up front, which doesn’t happen when you just short the shares. So, for example, you can short 100 shares of VXX at the current price, or you can sell an at-the-money VXX call and receive a handsome premium payment up front (in this case, you might or might not end up getting assigned and taking a short position in 100 shares). For folks who have a strong desire to take a short position in 100 shares, selling a deep-in-the-money option could be a better choice. Either way, you get paid to potentially take a short position in 100 shares, unlike the person who simply shorts the shares. The net effect is that the option seller is shorting the shares at a higher price, after the premium payment is factored in.
  • Folks who short-sell shares and hold their positions for a while will typically pay interest because the broker is borrowing shares on your behalf. Selling options doesn’t incur this interest charge unless the option seller ends up getting assigned and chooses to maintain a short position on 100 shares.
  • I already mentioned how option sellers are, in effect, shorting shares at a higher price due to the collection of a premium payment. For out-of-the-money option sellers, this benefit can be multiplied substantially simply by the act of selling out-of-the-money, since they would be assigned at a higher price. For example, let’s say UVXY is currently at $11.50 and someone decided to simply short 100 shares. Meanwhile, I would sell, let’s say, a 20-strike UVXY put expiring in 45 days. If volatility spikes and UVXY rockets past 20, I’ll most likely end up taking a short position on 100 shares of UVXY at $20 (plus whatever small premium payment I received), which is a much better position than the person who shorted the shares at $11.50.
  • Short-selling shares of the “hard-to-borrow” UVXY or VXX is a hassle with many brokers; in fact, some brokers won’t allow this type of transaction at all, while others make it difficult or inconvenient. Selling options on UVXY or VXX is an easier process with many brokers. Indeed, it has been said that with some brokers, it’s easier to take a short position in 100 shares by selling a deep-in-the-money call and getting assigned, than by contacting the broker and requesting to directly short-sell the 100 shares.
  • Two words: theta decay. Option sellers benefit from it, while share shorters do not.
  • Two more words: volatility collapse. Sure, share shorters will benefit from market volatility declining, but option sellers will also benefit from that, and they get the added benefit of the volatility component of the option premium’s price declining. In other words, both strategies receive benefit from the underlying asset declining when market volatility declines, but option sellers also benefit from the way the options market doles out extra punishment when markets calm down.

Then there are disadvantages that are inherent to both methods:

  • Margin requirements are high for both methods.
  • If no hedging strategy is added, then the maximum loss is “undefined” (unlimited) with both methods, so it’s possible not only to wipe out one’s entire account, but to actually end up having a negative balance and owing money to the broker.
  • Both methods require permission from one’s broker and are typically not intended for small accounts (or weak stomachs).

Both methods have their merits, and I’m certainly not denigrating the strategy of simply short-selling shares of UVXY or VXX.  For multiple reasons, however, I’m going to continue entering my positions through options trades. How about you?

 

 

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10 Comments
  1. RonTurkey 3 years ago

    The longer i participate in the volatility world, the more appealing shorting naked calls becomes. When I was a beginner investor, one of my rules: NEVER SELL NAKED CALLS – but, as that pertained to a normal stock – it doesn’t apply to uvxy, vxx, or vixy. Needless to say, as i become more experienced, that rule doesn’t apply. You briefly touched base on permission with your broker, but it is highly advisable to get WRITTEN PERMISSION from your broker that your account has the ability to hold a short position if the calls get exercised. For TDAmeritrade – you need to be signed up in their HARD TO BORROW program – otherwise, those shares may likely get margin called the Monday following exercise – first hand experience. Fortunately – I was allowed to keep my shares, but I’m betting some get stuck in similar circumstances and were forced to cover (at a higher price).

    • Author
      David Moadel 3 years ago

      Thank you RonTurkey for the cautionary advice. Indeed, getting it in writing isn’t a bad idea at all. I’m just glad that TD didn’t liquidate your short position at an unfavorable price!

  2. Sunil Narayana 3 years ago

    Thank you for detailed article. How different would it be with debit puts or put spreads doing the same.

    • Author
      David Moadel 3 years ago

      Debit vertical puts or put spreads on UVXY or VXX are a good alternative to credit calls or call spreads. However, the credit positions typically benefit from theta decay, whereas the debit positions typically do not benefit from theta decay and are often harmed by it. Still, the debit positions are easy to execute, with hardly any of the hard-to-borrow and margin issues that beset many traders who wish to short-sell shares of UVXY and/or VXX.

      • Sunil Narayana 3 years ago

        Thank you David…. Is it successful in weekly trades with credit call spreads..while you mentioned put spreads are better with 3-6 month range. Possibly a stupid question…if options are better risk managed..why is Seth so particular on layering the shorts. Thanks

        • DG 3 years ago

          Was going through articles and found this one. Have been thinking a lot about this and have done both. Given the longer term profile of these instruments shorting the shares offers a better return over time. If you sell 10 uvxy calls for 1.50 you make the 1.50 instead of a likely 75-90 percent return over the longer term. Thinking out loud.

  3. Richard Jenkins 3 years ago

    Another option if you are unable to find shares to short is that you can do a synthetic short by buying a put that is financed by selling a call at the same strike. This will give you the same negative 100 delta as shorting 100 shares.

    You will usually need to pay a debit to put the position on, but you will also notice that the debit paid is surprisingly near what the cost to borrow UVXY shares is(for an equivalent time period)…funny how that works.

    • Author
      David Moadel 3 years ago

      That’s actually a good alternative to shorting shares, Richard. It has the same risk profile and doesn’t require begging one’s broker to find shares to short before placing the trade.

  4. JamesBradley 3 years ago

    Great article David! It really spells out and clearly states your participation choices in this arena.

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