VIX is a trademarked ticker symbol for the CBOE Volatility Index. It measures the predicted volatility of the stock market over a certain period in the future. According to Wikipedia, it was first developed and described by Menachem Brenner and Dan Galai in 1986. At that time, Professor Brenner, in addition to his work at New York University, participated alongside me as a market-maker on the floor of the New York Futures Exchange Trading Options on the New York Stock Exchange Index. Until today’s research for this article, I had no idea that Professor Brenner had first developed and described the index.
Since I haven’t spoken to him in approximately thirty years, I’m not sure he’d agree with my assessment of the VIX as an inappropriate vehicle for customers to manage and speculate on Volatility. Not only are the Option Prices comparatively wide, but the Price of the Underlying Cash VIX is typically unrelated to the Price of an Options Series such as the one shown below with a June Expiration. The Table below shows numerous Puts and Calls for the June VIX expiration. The price of the Options Contracts have nothing to do with the Cash Price, shown as Friday’s Last Price, but rather as the Price of CBOE VIX Futures for June Expiration. The June VIX Futures Contract Settled at 18.325 on Friday and is in line with the Prices for the VIX Options below.
People will Purchase VIX Calls if they believe that the Stock Market, as represented by the S&P 500, will show an increase in Implied Volatility in their Options. Instead of Trading S&P or SPY Options, you can use the VIX as a Proxy for Trading Implied Volatility. The only problem is that the Bid/Ask Spread is typically wider than in either S&P Market, and the Calculation of the Value of the VIX is often difficult to decipher. If you Buy or Sell an S&P Options Contract the Greeks are clear and the Implied Volatility is easy to calculate. If you trade the VIX Options, the values are not.
Whenever you Trade Options, you want to get the best value possible. The Table below shows the Liquidity Percentage or the width of the Bid/Ask Spread and as far as I’m concerned, that makes Trading the VIX Options a non-starter. By the time you give up the edge getting into the trade and again later when you are liquidating, you have given up too high a percentage of the value of the asset to make money consistently in the long-run.
While CNBC may discuss the VIX all of the time and shows it as an essential Index throughout the broadcast day, it doesn’t mean that it is an appropriate instrument for Trading. Using the VIX to evaluate the movement of Implied Volatility in the S&P 500 is a valuable way to make comparisons in Implied Volatility levels. It presents a single number which can be used for a comparison. If one wants to Buy or Sell Volatility, however, there are numerous Options Trading Strategies in the S&P which can provide an opportunity to execute a Volatility Trade with good value.
Whenever Trading any instrument, it’s important to understand the components of what you are Trading. I try to shy away from any instrument in which the construction of the product you are Trading is too complicated. Futures Contracts are usually easy to understand while numerous ETFs have Structures which includes fees and calculations that don’t necessarily mimic the underlying that they are trying to emulate. There are ETFs in Gold and Crude Oil which fall into this category. The goal is always to trade in a market that provides excellent liquidity and transparency. While the VIX is a useful tool for referencing Implied Volatility, it doesn’t meet the requirements of liquidity and transparency. If you have any difficulty understanding analysis in our articles, contact us.
Please make note that in the Table the VIX is priced at 14.72, however, the 18 Calls are priced about 35 cents higher than the 18 Puts. The prices of the both the Calls and Puts creates a Synthetic Price the VIX for the June Expiration, at approximately 18.35 or very close to the Friday Settlement Price of the June VIX Futures of 18.32. To review synthetic prices, in and out-of-the money Options and other essential Options Trading Information try the PDF. If you are Trading VIX Options, like millions are, you have to analyze the VIX Futures. Either way, you must make sure you are Trading Liquid Markets.
Options trading involves significant risk and is not suitable for every investor. The information is obtained from sources believed to be reliable, but is in no way guaranteed. Past results are not indicative of future results.