Lately, I've received many inquiries about options on the volatility index, symbol VIX. The VIX has been around for many years, but it wasn't until just recently that the options started to trade on the VIX. VIX was designed to be a consistent, 30-day benchmark of expected market volatility (implied volatility), as measured by using At-the-Money S&P 500 index (SPX) option prices. VIX options can be used to speculate on how volatile the entire market place will be as a whole. In other words, VIX options' activity can suggest an answer to the question: will the implied volatility of the market increase or decrease in the future?
The concept is pretty straight forward; unfortunately the settlement and terms of the VIX option contract are not. The most confusing thing about VIX options is that the price of the quoted VIX Index has little to do with the value of the option contracts. This is because the actual index is not tradable, but there is a futures contract based on the index that is traded. Because the only tradable underlying security is the futures contract, naturally that becomes the hedge that market markers who are pricing the options have to use. This creates havoc when retail customers try to determine what the underlying value is for the option.
This is probably better explained in an example: the October options will be priced based on the October future, while the November options will be priced on the November future. These two futures will more than likely trade at very different prices. In this case the October future on 9/5/06 was trading at 139.50, while the future is 10 times the value of the VIX, implying a VIX index (or spot) value of 139.50/10 or 13.95. Simultaneously, as of this writing the November futures contract had a value of 159.80, implying a VIX index value of 159.80/10 or 15.98. Meanwhile, the actual VIX index value at that point was 12.63. A crucial first step to trading VIX options is to understanding what the underlying price is for the expiration you're interested in.
As of 9/5/06
October VIX Future - 139.50 or 13.95
November VIX Future - 159.80 or 15.98
VIX Index - 12.63
Unless you have access to future quotes you won't have access to the value of the index. One place to get a delayed quote on the future is the CBOE's web site; they also offer a useful video tutorial on the VIX. The symbol convention for the October future is VIX/V6. The last V represents the month, October, and 6 stands for the year, 2006. The Letter symbols for the months are below.
F January
G February
H March
J April
K May
M June
N July
Q August
U September
V October
X November
Z December
Know that VIX options are a truly wild, speculative ride. Plan your risk and exit strategies accordingly.
The next step is to understand how VIX expirations works -- check back in my next post for this one.
Regards,
Brian (OG)
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options.
While the volatility index (VIX) represents the consensus of the marketplace as to the future level of stock price volatility there is no guarantee that this forcast will be correct.
