The VIX estimates volatility on the SPX itself for the next 30 days.
VIX futures are a bet on where the that estimate will be on the day the future expires. In other words, it is a snapshot of what the market expects for volatility 30 days AFTER the future expires. If it is a September future for example, you are guessing how the market prices volatility 30 days forward from September expiration. You are not betting on SPX volatility between now and September, that is a common misconception.
VIX options are cash settled, meaning you get delivery of nothing, just a debit or credit. They are also European exercise, meaning you can't do anything other than trade them between now and expiraiton.
They price off the futures, NOT the VIX you see on the screen. And since futures carry premiums to the VIX when the VIX has an extended decline, VIX calls here look fat to the naked eye that only compares them to the "cash" VIX. The reverse is true when the VIX runs high; VIX calls can and do trade under parity and puts looked pumped.
Of course moves in the cash VIX have some effect on VIX futures and options, but the further out you go in time, the more limited that effect. Think of this weather analogy. A hypothetical October Weather future let's you predict the average temperature in Al Roker's 5 Day forecast on October 15th. Would an unseasonably warm or cold day today effect your prediction of his prediction? Not a whole lot. Same way a move in the "cash" VIX should not have much impact on your prediction where traders will price volatility looking forward in October.
So bottom line; trade VIX options and you are trading a derivative (the option itself) on a derivative (the VIX future) on an estimate of a derivative (the VIX itself is merely a statistically calculated estimate of a theoretical SPX option with 30 days until expiration).
9 comments:
One aspect of the VIX options that should clue people in right away that it's funky, is that you can put on a long calendar spread at times for a credit. I'm sure a lot of people saw that and sold the farm to get into those type of trades...so how about just trading the VIX futures?
certainly preferable to the options, at least it's one layer less complex.
Thank you! I think.
Rick
your welcome.....I hope.
Speaking of thanks, add mine to the list.
This post has become the centerpiece of my post on VIX options today.
Cheers,
-Bill
Adam, nicely explained.
Now, the question is, is there ANYONE who makes 7 figures sitting behind the set desks at CNBC who could
a. explain what you've explained
b. understand what you've explained
c. put the kabosh on anyone ever again at CNBC who talks about the VIX in their all-too-typical unnuance ways?
Maybe David Faber. But the rest of the hairspray, balding, toupeed (sp?) crew?
Fuggedabodit!!
tanks.
Wouldn't make good TV though, better to just say volatility is cheap so you should buy it than actually getting into what exactly that means.
Agreed with the above commenter...Adam should be the volatility guy on CNBC..i would turn the mute off lol. If you bring along some of those French news anchors to articulate the relative cheapness of volatility..it just may be good tv!
PS-- Last night while i slept..a lepracahn with rolled up sleeves claiming to be Cramers second cousin removed, appeared near my bedside and told me to go short Vol. prior to "The Look"...
..gonna have to fade this one I think lol
tanks. I could do like that Peak Oil video and talk about the VIX while Melissa is on the other half of the screen.
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