I Don't Like Mondays

Actually I don’t dislike Mondays more than any other day, but that is a title that I can get a funny picture to go with.

In the last few blog posts, I wrote about how equity options don’t fully account for the weekend and that there is edge in selling on Friday. In this post I’m going to briefly look at how we can exploit the same effect in the VIX.

It is well known that the VIX tends to be up on Mondays. This effect has been consistent, and highly statistically significant, since 1990. The average return by day of the week is shown in Figure One.

Figure One: The average (log) VIX returns by weekday.

There is a structural reason for this. The VIX is based on calendar time. It uses actual days to expiration to calculate the variance swap it is based on. So if an option is priced at 5 on Friday afternoon, and opens at 5 on Monday, the VIX calculation thinks that implied volatility has to have increased because no time decay has occurred even though time has passed.

But the options’ market realizes that weekends do actually exist so they tend to anticipate lower volatility on Fridays. The VIX drops on Friday due to this. If traders perfectly accounted for the amount of volatility on weekends there would be no trading opportunities, but the last two blog posts suggested this isn’t true. So let’s look at the daily returns of VXX.

Figure Two: The average (log) VXX returns by weekday.

The fact that all days have negative returns shouldn’t be a surprise. Much has been written about the decay of VXX (and some of it is even sensible!). But what might be more surprising is that Mondays have the worst returns of all. The day the VIX is up the most corresponds to the day when VXX is down the most.

There are two reasons for this. The reason VXX “decays” is that the VIX futures curve is generally in contango, so keeping a 30 day duration generally involves buying higher priced futures and selling lower priced futures. Doing this results in a daily loss. On Monday VXX essentially has three days of losses.

But the other reason is also important. The option market makers don’t perfectly account for the weekend. If they did, there would be no edge in selling options over the weekend. They actually attribute more value to the volatility of Saturday and Sunday than they should. This is probably nothing more than risk aversion. There is always the chance of a major event happening on Saturday or Sunday and market makers don’t like the chance of this happening when even the overnight markets are closed.

Direct trading takeaways from this:

  • If VIX is an input to any trading decisions you make, account for the Monday effect.

  • If you can handle the perceived risk, selling index options or VXX over the weekend is a good trade.

Euan Sinclair2 Comments