Why not play for a volatility pop with VIX calls?
Primarily because the guy on the other side of the trade understands them better than you do. Particularly if he is running a big derivatives portfolio with all sorts of variance risk, while you are seeing the recent VIX poundage and want to speculate that has gotten overdone. And you don't fully understand the bet you are making here. Which is absolutely nothing to be embarrassed about; it's an extremely confusing product masquarading as something not so complex.
The VIX is an estimate of a derivative; the volatility of SPX options. VIX futures/options are thus derivatives of a derivative.
Yes, there are 2 VIX's. The "spot" calculation you see on every screen and the tradable VIX products. Even with the "spot" VIX near 18 Friday, and 19 today, you could never actually buy it at either price. VIX futures are a cash-settled product that essentially lets you "bet" not on where the VIX goes today, but where it will close on the day the option expires. And they are European exercise, so you can't do anything with VIX's you buy, other than sell them back out.
An common analogy to this is the weather. Let's say there was a contract that let's you bet on the temperature on Halloween. The fact that it went from 50 degrees and rainy on Friday to 70 and sunny today would have about zero effect on that bet. Same as if you bought VIX paper on the unseasonably cold levels of Friday and planned on riding today's "spike".With the VIX at these levels, futures and options are all assuming "mean reversion" up. Even May paper is already pricing in a move to 20 before you would begin to profit.
If you believe volatility is too low and would like to buy some options, I would strongly recommend just buying options on actual stock or indices (or bond or commodities, or whatever). Something as simple as taking off a stock winner and replacing it with calls, or instead, just buying some puts as insurance, are as sensible "bets" on volatility as anything.
8 comments:
I've noticed the same thing with Index options, they are almost always overpriced. The ETF options on the other hand seem to be a lot more reasonable.
I wonder if what is gonna happen with those new FROs coming out soon: http://amex.com/options/prodInf/OptPiFROs.jsp , looks interesting.
it's also that with option pummelled, the marts assume it will "revert". Markets spent 2-3 years with that erroneous assumption into the spring of 2007, so it can last a while. I don't think that will be the case this go around.
Thanks for that FRO stuff, got to look into it. Sounds like a "bet" you can make now on Hedge Street or InTrade. Interesting.
OK, who is she?
Adam, as you point out, the VIX really exists for institutional traders, who may have significant vega exposure and need to hedge that exposure.
Us retail schlubs should avoid it for the toxic substance that it is.
take 10 Salma calls, no limit ;-)
anon: Selma Hayek, in honor of the holiday. And what sysin said.
Karl: yeah, it's just a whacky product that really only has use for real pros with big books. Most everyone else just picks spots without full understanding of the bet. It's like playing Texas hold em with poor strategy; we can win sometimes but play enough and all the money will go to the pros.
If you're going to make a directional play on the VIX, you would certainly want to use spreads or some other manner of trade which will allow you to hedge your "VIX vega" exposure. Also the bid/offer is pretty ridiculous in VIX options, much better to stick with variance swaps if want to trade vol.
My general advice (certain applies to me) is that if you can't trade variance swaps you probably shouldn't be trading vol.
yeah, that applies to me to, and I would definitely agree.
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