I was interviewed last week for the Wall Street Journal’s Marketbeat column about the VIX – specifically, about the fact that this widely quoted measure of market volatility, often nicknamed the “fear index”, has stayed over 30 for over a week, indicating an unprecedentedly sustained level of uncertainty among investors.

If you’ve been watching this number closely, too, you might be fishing around for trades to take advantage of this number eventually popping. As I told WSJ, one big factor that’s likely keeping the VIX high in the short-term is the delay in passing a financial-sector bailout package through Congress. So I’m sure quite a few of you are mulling trades timed around that factor.

Now seems like a good time to revive my blog series on the VIX and to offer a word of caution. VIX options can be tricky animals to trade for one important reason: the options are not based on the actual VIX, but on the values of the VIX future contracts. It’s not at all uncommon for short-term fears reflected in the VIX to spike, while longer-term VIX futures don’t budge a bit. Make sure you’re briefed on how these relationships work before you dive in head-first.

The first post in my VIX series explains this phenomenon; the second post continues that explanation in more concrete detail, comparing VIX futures to more conventional commodities futures. Bottom line: you might want to stick to shorter-term VIX options, so that you can keep a better handle on short-term relationships between the futures and the options based on them. Finally, this post offers even more educational background on the VIX and VIX futures, including some relevant links to TheStreet.com and the Daily Options Report.

I can’t caution you enough about doing your homework before heading into VIX options trading – it’s a wild, speculative ride, to say the least. Still, if you’re well-briefed there may be a historically unusual trading opportunity hidden in these sky-high VIX levels. Definitely report back to us here if you choose to hop on that ride – especially if you can share some lessons-learned along the way!


Regards,
Brian (OG)

[image: Fear – Graffiti by Jimee, Jackie, Tom & Asha on flickr]

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.

While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.

Any strategies discussed or securities mentioned, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities.  

Is their a way to trade the VIX at the spot value? I.e. with the VIX at 45, is their a way to bet it will do down from here, without having to mess with getting the level of the VIX right at the OCT options expiration?

Hello Ameds,

No, unfortunately there is no way to just trade the spot value of the VIX index. They would have to introduce an EFT on the actual VIX value and that will probably never happen. There are two products that are tradable at TradeKing, the options on the VIX index and the binaries. Both of these products are priced based on the VIX future not the actual index value of the VIX (ie. Spot Value).

Regards,
Brian (Og)

Brian it sounds by your blog it is really the area for proffesional traders not retail investors?  Is the VIX typcally used to hedge positions by proffesional traders or is it an income for hedge funds and the like?  I notice unusual call volumes at times in these options and sometimes wonder why people would even go in them other than proffesional traders.  Do you have any insight from the CBOE who buys or sells these options in large quantiies?

One thing I do like about .vix options (don't own any .vix now, but own VXN puts [NASDAQ volat]), is it's a great way to hedge if you are long volatility on options against equities. I bought some front month VXN 25 strike puts a while back (with the madness now, they might just expire).....but if things calm down and I don't get my anticipated straddle results, then I'm hoping I will at least be able to comb some money off of being short volatality and can cut & run on some of my option straddles.

Hello Pauly B,

Great observations and questions. The options on the VIX I think are more of a speculation index then a hedge. I really think it is a 50/50 mix of retail traders and professionals. The actual implied volatilities of the options contracts are many times over 150%, which does make the product a tricky one for the average investor to trade. One thing I really like about the VIX is that it truly is a mean reverting index. I mean the VIX will probably never go to 500 hundred like Google and it will probably never go zero like Enron. If you sell a 30/32.50 strike call credit spread (bearish) on the VIX and the index spikes to 60 you are not done. If it was a normal stock the chances of it coming back down below 30 are slim to none, but in the VIX index because it is mean reverting, the index could be below 30 a day later.

The new binaries options are easier to trade. I think retail people can really get a solid grasp on the binaries. THE ONLY tricky part is knowing that the prices are based on the future not the actual value of the VIX index (Spot Value). With the VIX being at 40 for the past week I do think a lot of people would like to learn more, so my Monday's post is going to be on the VIX binaries.

Regards,
Brian (Og)