Be careful with VIX calendar spreads

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VIX calendar spreads are one of the trickiest plays in the option world, so much so that some brokers don't even allow them. This isn't to say that they cannot be useful, but one needs a sound understanding of the dynamics involved.

A " Volatility Playbook " segment on CNBC's "Fast Money" last week highlighted a VIX option recommendation by Bill Lefkowitz of vFinance Investments. He recommended a short diagonal spread in the VIX, buying the March 29 calls for $3.40 and selling the June 35 calls for the same price.

Buying nearer-term VIX calls and selling longer-term calls at a higher strike can be a good long-volatility play . In this case, however, there are some important issues to consider.

For one, the pricing revolves around the dynamics of the VIX futures, off which those respective options are priced. If we get a big equity selloff in January, then the VIX will rise--potentially in a big way. But the March VIX calls are priced off the March VIX futures, which will not have as big a reaction.

It is a bit like the weather: Just because yesterday was 20 degrees warmer than usual for December, it doesn't mean that it will be 20 degrees warmer three months from now.

So for starters, the March calls may not give you the long-volatility position that you desire or one that is reactive to a volatility spike now. On the other side, if we don't get the volatility spike as we close in on March, those calls will decay at a much faster rate than the June options.

Lefkowitz makes some perplexing statements in this regard, including a comment that the spread costs no money. While it is done for even money--the bought and sold calls are worth the same price--your brokerage will see you are short the June VIX calls and margin your account accordingly.

But Lefkowitz says that, because they are done for even money, "you shouldn't lose any money at all so you have no risk for 90 days." This, of course, is ridiculous.

We don't know what will happen in the next 90 days, but let's say the VIX climbs to 28 by March expiration. The March 29 calls will expire worthless and you will have lost $3.40, but the June calls could still be worth $3.40 or even more. So there is definitely risk of loss here, even if it is limited.

This type of VIX call spread can be a really good way to put on a long volatility position and take advantage of the VIX term structure . But you'd better understand the dynamics--and the real risks--or you should take a pass on such recommendations.

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