Trading Strategies for VIX Options
VIX options are options on the Cboe Volatility Index (VIX), which measures the market's expected 30-day volatility of the S&P 500. They differ from stock options in three ways: they are European-style (exercisable only at expiration), they are cash-settled because you cannot own the VIX itself, and they are priced off the VIX futures contract for the same expiration rather than the spot VIX. Traders mainly use them to hedge a stock portfolio against a volatility spike (long VIX calls) or to express a view that volatility will fall (long puts or call spreads). This article is educational and not investment advice.
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Understanding VIX Volatility
The CBOE Vix, or the Volatility Index, is a measure of the expected volatility of the stock market over the next 30 days. It is derived from the prices of put and call options. The Vix index can be used as a tool by traders to identify whether the market is experiencing large price swings or low volatility.
High Vix values indicate high levels of uncertainty in the market and signal that large price swings could be expected in the near future. Low Vix values signal that the market is expected to be calm and there may be few large price movements.
Vix Calls and Puts
VIX calls gain value when volatility expectations rise, and VIX puts gain value when they fall. Because VIX options are European-style and cash-settled, they pay the difference between the settlement value and the strike at expiration instead of delivering any asset.
Vix Derivatives, Futures, and Options
Traders can take advantage of the various derivatives and futures contracts of the Vix. These include Vix futures, options on Vix futures, and options on volatility indexes.
VIX futures are contracts that obligate both sides to settle at the VIX special opening quotation on the expiration date; unlike options, they are an obligation, not a right. The options on Vix futures give the trader the right to purchase or sell Vix futures at a predetermined price and on or before a predetermined date.
Options on volatility indexes allow traders to speculate on the direction of an index of volatility such as the Vix. Options on volatility indexes are useful for traders looking to hedge their positions.
Trading VIX Options
The common VIX option strategies are buying calls, buying puts, and spreads. Covered calls and protective puts do not apply directly, because you cannot own the VIX index as an underlying.
Buying calls allows traders to benefit from rising Vix prices while also limiting the risk of incurring a large loss. Buying puts allows traders to benefit from falling Vix prices while also limiting the risk of incurring a large loss.
Call and put spreads (buying one strike and selling another) reduce the premium paid, which matters because VIX options can be expensive when volatility is already elevated.
Understanding VIX Options
Traders who are interested in trading Vix options need to understand the various strategies associated with these contracts. It is important to understand the basics of volatility as well as the underlying strategies of buying and selling calls and puts. Additionally, traders should understand how to use derivatives and futures contracts to hedge positions.
A long straddle buys a call and a put with the same strike and expiration, and it profits when the underlying moves sharply in either direction. For more information on this strategy, please visit the MarketXLS Long Straddle workbook.
Conclusion
VIX options let traders hedge or speculate on changes in expected volatility, but they settle off VIX futures, not spot VIX, and are European-style and cash-settled. Long options limit the loss to the premium paid, which can still be the full amount.
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