Beware Of Getting VIXed

“Buy the VIX”. After all, it is the perfect hedge. It was up 40% on Friday while the S&P 500 slipped 2.5%.

But there is a distinct problem. You can’t trade the VIX. The VIX is the implied volatility of the SPX options. It is a calculation and the options it is based off of are constantly changing.

VIX Daily Close

You can, however, trade the VIX futures. But those require a serious learning curve. The front month futures were only up 22 percent as they were already pricing in higher volatility. And the farther out futures had gains that were even smaller due to the Contango (if that last doesn’t make sense then you really shouldn’t be trading the futures). That means that for the vast majority of the time, the VIX futures are higher with each successive month.

You could trade the VIX options. But those options are NOT priced off the VIX. They are priced off the VIX futures. Given the fact that the futures are all different prices, it makes the VIX options unlike anything else in the “equity” options arena. This can create distinct problems. For instance, VIX calendar spreads can – or could – be put on for a credit, which isn’t something that can be done in any equity options (and had serious financial ramifications for at least one big broker). It is also the reason that on Thursday when the VIX was at 12, the October calls were trading for $3.90 and the puts for $0.10 with implied volatilities of 190% and 26% respectively.

VIX Index Level

Finally, you can trade the VXX or other VIX ETNs. But once again, as given away by the name, the iPath Short Term VIX Futures Note, these are based off the VIX futures, not the VIX. The VXX is comprised of the front 2 month VIX futures. On Thursday that means that with the VIX down at 12, the fund was partly based on the September futures trading 14.3 and the October futures trading at 15.2. Not only are those sizable premiums, but it also has a daily roll, every day selling the lower cost front month futures and buying the higher price second month futures (when the usual Contango exists). So the VXX was up 16 percent on Friday’s big move lower in equities. That is still a great hedge, but take into account the fact that split adjusted (there have been a few) it started in February of 2009 above 25,000.

So the VIX can be incredibly useful. But it can’t be traded. The VIX tradable products are amazing vehicles that can do many things for you, but you really better know what you are talking about when you start to dive in, because with these, you are really in the deep end.

Chris McKhann

Chris McKhann

Chris McKhann has been involved professionally with the stock market for more than 15 years and specifically with derivatives for 12 of those. He started as a stock broker, but quickly moved on to options and futures trading. He spent some time as the Derivatives Product Manager for TD Ameritrade. He was the chief analyst and hedging strategist for OptionMonster. He has been an options trading educator and content provider for many years. His writing and analysis has been featured on Reuters, the Wall Street Journal, Forbes, TheStreet, CNBC and internationally. He has also designed and traded option and futures strategies for prop trading firms and hedge funds as well as managed accounts.

Leave a Comment