Article / 08 February 2016 at 14:06 GMT

Volatility Update: Options for volatility traders expand with VIX

Product Manager, Options Trader, Educator
Denmark
  • Saxo Bank last week listed weekly options on the VIX volatility index
  • The CBOE volatility index is a widely used barometer of market volatility
  • Increasngly sophisticated retail traders are expanding their strategies to VIX options
  • Before trading VIX options, investors should learn the specifics of the contract
  • Our weekly OptionsLab webinar on Wednesday will discuss diagonal spreads 

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 Want to take a new perspective on volatility? Photo: iStock


By Georgio Stoev

Last week, Saxo Bank listed weekly options on the VIX volatility index (VIX), so today we provide some basic information about the VIX and trading of the weeklies.   

For volatility traders the world's largest options exchange, the Chicago Board Options Exchange (CBOE), has listed a wide range of volatility products from volatility on indices and futures to rates and individual stocks. Among the dozens of such products, the CBOE volatility index is a frequently mentioned barometer of market volatility. We also refer to the VIX in our weekly Volatility Update reports.

Definition of the VIX

The VIX uses prices on the S&P 500 Index (SPX) options, and it is constructed to reflect investors' view of the 30-day implied volatility (IV). The IV is often referred to as the extrinsic (time) value of an options price. 

Here are a few basics you should know about the value of the VIX:
1. The value of the VIX is derived from the volatility value of SPX options, not the intrinsic value.
2. The implied volatility of the closest to the at-the-money options is used.
3. The VIX and SPX have an inverse relationship: when the S&P 500 Index falls, the VIX tends to rise; and when the SPX rises, the VIX falls. 
4. There is no strong correlation to indicate that when the VIX rises the next 30 days are going to be less volatile than the previous 30-day period, and vice versa. 

Simply said, when investors optimism rises, the implied volatility in options will decline as investors' demand for puts diminishes. Conversely, when uncertainty rises, investors seek put options for speculation or hedging. Hence the inverse relationship.

VIX inverse relationship
 

The Volatility Index listed options back in 2005, and the contracts quickly became the choice for many (mostly) institutional traders. Today, as retail investors become more sophisticated with their selection of products, their strategies and technology are also extending to VIX options. Some trade the options to hedge in the market, others to speculate. As a note, the correlation between SPX and VIX is generally 7.8 points. A point fall in the SPX could translate into a rise of 7.8 in the VIX.

Trading the VIX

As noted above, Saxo Bank last week listed weekly options on the VIX index. The weekly options for the index are listed every Thursday and expire the following Wednesday. Weekly options were first listed in 2005, and since then weekly options have existed for stock options, indices and exchange-traded funds like SPY. Traders could choose to trade weekly options for the same reasons they trade standard options. The main difference is that they could do it four times a month rather than once. 

VIX Weekly
Because of this short-term maturity and the accelerated time decay, most traders prefer to sell weeklies rather than buy them. Covered call, naked puts are examples of some selling strategies that attract investors for these listings. Spreads are also frequently used with the instrument, especially credit spreads as well as calendar and diagonal spreads. 

Please join us for the Weekly OptionsLab webinar on Wednesday this week to learn about diagonal spreads from Shawn Howell, co-founder of ProMarket Advisors LLC. (Click here to sign up.)

Although traders, particularly those who are short, could gain an edge with VIX weekly options because of the rapid time decay, beginner traders should be aware of some of the following items before using the product:

  • VIX weeklies are European-style options and settle in cash 
  • VIX options expire mid-week while most equity options, including ETFs, expire on Fridays
  • Especially when going long, be aware of the rapid time decay, which is against you
  • Investors may also find wider spreads between the Bid/Ask 

Before trading VIX options, investors must take time to learn the specifics of the contract, such as expiration, exercise style, last trade and so on. Information about this is available on the CBOE website: http://www.cboe.com/products/indexopts/vixoptions_spec.aspx

Have a great week.


— Edited by John Acher

Georgio Stoev is futures and listed options product manager at Saxo Bank. 

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