SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

How Does VIX Work?


The CBOE Volatility Index® (VIX® Index®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, the VIX Index has been considered by many to be the world's premier barometer of investor sentiment and market volatility. 

VIX’s value

 

The VIX is based on option prices of the S&P 500 index (SPX). One component in the price of SPX options is an estimate of how volatile the S&P 500 will be between now and the option’s expiration date.  

 

The CBOE’s approach combines the prices of many different SPX options to come up with an aggregate value of volatility. Their approach has some advantages.

 

The current VIX concept is about the expectation of stock market volatility in the near future. The current VIX index value quotes the expected annualized change in the S&P 500 index over the next 30 days, as computed from the current options-market prices. 
 

What does the number mean?
 

For those interested in what the number mathematically represents, here it is in the most simple of terms. The VIX represents the S&P 500 index +/- percentage move, annualized for one standard deviation. Example, if the VIX is currently at 15. That means, based on the option premiums in the S&P 500 index, the S&P is expected to stay with in a +/- 15% range over 1 year, 68% of the time (which represents one standard deviation).
 

 

What does VIX track?

 

VIX tracks prices on the SPX options market. The SPX options market is big, with a notional value greater than $100 billion, and is dominated by institutional investors. A single SPX put or call option has the leverage of around $200K in stock value.

 

In general option premiums have inverse correlation to the market.  In a rising market, stocks tend to be less volatile and option premiums low which causes lower VIX values. Declining markets are volatile (the old saying is that the market takes the stairs up and the elevator down) and option premiums increase.  Much of this increase occurs when worried investors pay a large premium on puts to protect their positions.

 

While S&P 500 option premiums generally move opposite to the S&P 500 itself they sometimes go their own way.  For example, if the market has been on a long bull run without a significant pullback, institutional investors can become increasingly concerned that a correction is overdue and start bidding up the price of puts—leading to a rising VIX in spite of a rising S&P.   Historically 20% of the time the VIX moves in the same direction as the S&P 500—so please don’t claim the VIX is “broken” when you see the two markets move in tandem.

 

The daily percentage moves of the VIX tend to be around 4 times the percentage moves of the S&P 500, but unlike the stock market, the VIX stays within a fairly limited range. The all-time intraday high is 89.53 (recorded on Oct.24 2008) and the all-time intraday low is 9.39 (recorded on Dec.15 2006) with the current methodology. It’s unlikely that the VIX will go much below 9 because option market makers won’t receive enough premium to make it worth their risk.  At the high-end things go could go higher (if the VIX had been available in the October 1987 crash it would have peaked around 120), but at some point investors refuse to pay the premium and switch to alternatives (e.g., just selling their positions if they can).

 

How does VIX trade?

 

There is no way to directly buy or sell the VIX index.  The CBOE offers VIX options, but they follow the CBOE’s VIX Futures of the same expiration date, not the VIX index itself.  VIX futures usually trade at a significant premium to the VIX.  The only time they reliably come close to the VIX is at expiration, but even then they can settle up to +-5% different from the VIX level at the time.

 

There are around 25 volatility Exchange Traded Products (ETPs) that allow you to go long, short, or shades in-between on volatility, but none of them do a good job of matching the VIX over any span of time. 

 

The most popular VIX related products are: iPath S&P 500 VIX Short-Term Futures ETN (ARCA:VXX), iPath S&P 500 VIX Mid-Term Futures ETN (ARCA:VXZ), iPath Inverse S&P 500 VIX Short-Term ETN (ARCA:XXV).

VIX-related ETPs can be used to trade long and short, to hedge, to manage risk etc. There are a wide range of VIX-related ETPs on the market, including pure VIX futures-linked products, that can be long, leveraged long, or inverse.

 

VIX Futures


This is as close to a pure play as you will get, and it's what all the other instruments revolve around. The most important thing to understand: VIX futures don't track the spot VIX on a 1:1 basis.


VIX futures are an estimate where the VIX will be at a certain date, not where the VIX is right now. This is what is called a "forward" contract.


The VIX futures have their own kind of supply and demand and it reflects the expectation of where the VIX will be around the settlement date of that particular future.


VIX futures have a cash settlement. As we get closer to the settlement, the spot VIX and futures price will converge. but until then the market will attempt to guess where the VIX will be by a forward date.

VIX Options
 

VIX options do not trade based off the spot VIX. Instead the underlying is based off the forward expectation of where the VIX will be. Eventually, the spot VIX and the forward readings will converge as expiration closes in, but for the most part there will be a difference in the two values.
 

VIX options have a cash settlement-- meaning if you are short in the money options, you can't get assigned any VIX stock. Instead you will have cash pulled out of your account that is the difference between the strike of your short option and the settlement quote for the VIX.
 

The settlement value is called the Special Opening Quotation (SOQ). This value is based off the opening prices of SPX options. This means that you may think your short VIX options will be out of the money at expiration, but you can find yourself with a not-so-fun surprise if the SOQ runs against you because somebody decided to buy a ton of SPX options. We recommend never to hold VIX options into settlement to avoid nasty surprises.

 


The Bottom Line

 

VIX is complicated, you can’t directly trade it, and it’s not useful for predicting future moves of the market.  In spite of that, the investment community has adopted it, both as a useful second opinion on the markets, and as the backbone  for a growing suite of volatility based products.

 

If investors really want to place bets on equity market volatility or use them as hedges, the VIX-related ETF and ETN products are acceptable but highly-flawed instruments. They certainly have a strong convenience aspect to them, as they trade like any other stock. That said, investors looking to really play the volatility game should consider actual VIX options and futures, as well as more advanced options strategies like straddles and strangles on the S&P 500.


Related articles

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • How To Create Your Own Indexed Annuity

    Indexed annuities are a life insurance company product sold by insurance brokers for a commission that is based on the amount deposited into the contract. Contract performance is linked to popular indexes like S&P 500, and early withdrawal penalties typically apply for the first 7-10 years if withdrawals greater than 10% of the contract value are taken each year.

    By Jesse,

    • 0 comments
    • 878 views
  • Q&A with Mental Game Coach Jared Tendler

    QUESTION: Thank you for taking the time to participate in a Q & A session with Steady Option. Let’s start with an introduction and a little bit of background on who you are and how you got here.

    By Jared Tendler,

    • 0 comments
    • 1,102 views
  • Using TLT Options to Increase Expected Returns of a Buy & Hold Portfolio

    TLT is the iShares 20+ Year Treasury Bond ETF that seeks to track the investment results of an index composed of U.S. Treasury bonds with remaining maturities greater than twenty years. Even though US Treasuries typically act as a diversifying asset class to mainstream equities, many investors with long time horizons may not be interested in holding TLT in their portfolio because it would lower expected returns.

    By Jesse,

    • 0 comments
    • 1,315 views
  • Tax Efficient Trading Part II: Capital Gains Deferral

    In part I I illustrated how the preferential tax treatment of 1256 contracts could improve after tax returns of a PutWrite strategy over a long period of time. In this article, I’ll continue the illustration by switching from a PutWrite to an ETF BuyWrite (covered calls) strategy while holding pre-tax expected returns constant at 8%.

    By Jesse,

    • 0 comments
    • 1,618 views
  • Tax Efficient Trading Part I: The 1256 Contracts

    Cash settled index options like SPX, XSP, RUT and a few others receive special federal tax treatment where 60% of the gains are reported as a Long Term Capital Gain (LTCG) even if the contract was held for less than a year.

    By Jesse,

    • 0 comments
    • 1,600 views
  • SPY Short Puts vs. Put Spreads

    In this article I’ll be using the ORATS Wheel backtesting tool to compare the performance since 2007 of SPY short puts versus short put spreads. I’ll look at both risk and returns, and different ways of determining position size to adjust for the differences in risk between the two trades.

    By Jesse,

    • 1 comment
    • 2,407 views
  • Signs that you Are Ready to Start Investing

    If you want to build your wealth, you have to make sure that you invest your money. If you put money into a savings account and don’t earn any interest from it, this won’t work for you in the long term. Your money will lose value because of inflation, and this is the last thing that you need. So when do you invest?

    By Kim,

    • 0 comments
    • 1,733 views
  • One Year of Diversified leveraged Anchor

    I almost hate to keep saying it, but the Diversified Leveraged Anchor strategy keeps exceeding expectations and performing as designed. To remind our readers, Diversified Leveraged Anchor was created in April 2020 attempting to further increase performance, reduce risk, and to reduce volatility. 

    By cwelsh,

    • 5 comments
    • 2,814 views
  • Should I Pay Off My Mortgage Early Or Invest?

    Paying off a home mortgage early is a popular financial goal. Most people feel a level financial peace when their home is paid off that is beneficial in many ways. The most common approach to paying off the mortgage early is directly making additional principal payments to the lender on a regular basis.

    By Jesse,

    • 0 comments
    • 1,339 views
  • Option Order Execution Tips

    As a community of option traders, we all can relate to the occasional challenges of order execution. Best practices for avoiding errors as well as techniques for better potential execution will be the focus of this article.  Like countless others in the Steady Options community, I personally have traded thousands of option contracts over the last decade.

    By Jesse,

    • 17 comments
    • 2,958 views

  Report Article

We want to hear from you!


Good article.

What time can you trade VIX options? Can you trade them in pre-market?

Share this comment


Link to comment
Share on other sites


Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account. It's easy and free!


Register a new account

Sign in

Already have an account? Sign in here.


Sign In Now

Options Trading Blogs Expertido