VIX Fixation

faintingIt seems these days that the entire world is gasping at, of all things, minor twitches in out-month VIX futures. Earlier this week, Bloomberg’s strength ebbed and I caught them as, overcome, they whisper’d, “VIX Signals S&P 500 Swoon as September Approaches.” Like any financial headline that calls to mind men in breeches and whooping cough, this one should be regarded with skepticism. In the first place, VIX futures are signaling no such thing: even if the VIX popped up five points over the next week, that wouldn’t necessarily coincide with any rally-crushing, chaise lounge-requiring swoon. And it’s just as likely that the futures will fall to meet the current VIX spot level as it is that spot VIX will rise – we know this because that’s exactly what has happened over the past month, as documented in the Volatility Tracker. Adam has already dissected this piece, so see his post for more disapprobation. (Note that the frontal assault on our language continues unabated. I’m telling you, people, Bloomberg’s policy of calling every damn thing a “so-called thing” is just the beginning.)

Savvier traders, like member K.S., are thinking about whether to take the other side of the VIX doomsday view:

Do you have any suggestions on how to trade the contrary view that the VIX will not surge into the 30′s/40′s in the fall, such as selling VIX call spreads vs. buying put spreads?  I’m nervous about doing this due to the confusion on the part of the underlying — if I understand it correctly the options are actually on the VIX futures but the cash VIX and the VIX futures converge at the futures expiration — so on a trading basis the futures could drive different results if the futures are at a premium but at expiration they will converge.  Since thinkorswim uses the cash VIX as the underlying trying to monitor positions in VIX options has to be a little challenging.

This is correct on several key points. VIX options are indeed priced off of VIX futures, not the spot VIX, and the spot and futures levels do converge at expiration. Pricing VIX options is trickier than it may seem, since apparently no retail options broker links the options series and futures properly (and Bill has looked.) The best solution would be to roll your own pricing model in an Excel sheet, but that may be a bigger commitment than many traders are willing or able to make.

As to the question about spread selection: given that the VIX complex as a whole is still drifting to new lows for the year, buying VIX put spreads might not be the best idea here unless you have an extremely bearish view on volatility – or more specifically, on future expectations of implied volatility. Selling call spreads might be a better route, but I really don’t know if it’s necessary to use VIX products to express the view K.S. is espousing. If you doubt that realized volatility in SPX will be sufficient to sustain a VIX of 30-40 later this year, expressing that view might just be a matter of putting on a short vega position for the expiration you think is most overpriced, and delta hedging that position until it matures.  Strictly speaking, it doesn’t matter what option position you choose: a simple short put or call can be just as effective as a multi-legged spread, again provided deltas are kept in line.

By way of contrast, a position in actual VIX products would be necessary if you held a specific view about the implied volatility of implied volatility, which for most traders is a strange sort of view to have. VIX products appear exciting and exotic, and the CBOE is certainly marketing them aggressively, but I think about 95% of the views I hear from ordinary traders can be implemented just as effectively – and with none of the added pricing or expiration annoyances – with traditional index products. I don’t mean to come off as some sort of financial Luddite, but I think it’s a good rule of thumb to only use as complex a product as is required by the thesis being expressed.

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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