up-down-arrows.jpgAre you keeping tabs on the S&P 500 – who isn’t nowadays? – or wondering how you could trade the elevated levels of the Volatility Index (VIX), the so-called “fear index”? If so, you may want to look into binary or fixed return options (FROs) based on either of these two indices.

In a nutshell, these options let you trade based on your opinion of whether the S&P 500 or the VIX is headed up or down over a given timeframe. If you’re right, you’ll earn a fixed payout of $100 per options contract upon expiration. If you’re wrong, you earn zero. With only two outcomes, you can see why these are called “binary” or “fixed return options”.

If you’re not familiar with FROs, start off with my primer post on the subject. You can also read up on these CBOE-traded binary options here.  

A word of caution on VIX options…

If you read last Monday’s post on the VIX and related options, I should point out that these CBOE binary options are not based on the actual VIX, but on the futures that follow the VIX. (I dug into this in more detail in a previous post.) In other words, the markers on the floor of the CBOE use the futures to hedge their option trades.

What that means for you is these VIX binaries might not move as expected after the actual index moves. Keep an eye on the VIX futures product to understand why the binary options moved they way they did.  Make sure you quote the future with the same expiration month as the option contracts you are trading.

Here’s another wrinkle: final settlement of CBOE VIX binary options is based on the actual index; the future and actual index (what’s know as the “spot”) will converge as expiration approaches.  This is a general rule between the spot and future market. Read up on this at the CBOE product site for the full details on these contracts’ terms and how they trade.

Trading FROs and binary options at TK

If you decide to trade these, you can enter orders from Trading > Fixed Return (FRO). You can also get there directly from our Options Chains. Just select “Fixed Return and Binary Options” from the Chain Type pulldown menu.

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I’ve said it before, but I’ll say it again: I’d encourage would-be VIX options traders try to stick to shorter-term contracts. Those contracts will bear more relationship to the current moves of the VIX index, and you can strategize accordingly. By the same token, know that VIX options are a truly wild, speculative ride.  Plan your risk and exit strategies accordingly.

And let us know how your trade fares here! I’m happy to take your questions or just rehash ideas here.


Regards,
Brian (OG)

[images: leper – up arrow by redvers and down arrow by TheTruthAbout… 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.