VIX Options

VIX Options - Definition

VIX Options or VRO are non-equity options that use the CBOE VIX as its underlying basis.

VIX Options - Introduction

VIX Options begun trading in the Chicago Board of Exchange (CBOE) on 2006. VIX options come with both call options and put options, allowing options traders to trade volatillity directly using the full range of options strategies. VIX options can be traded in any standard options broker accounts by any options traders just like ordinary stock options. Before the invention of VIX options, there was no way traders and investors can hedge against or profit from volatility directly. VIX options does have some differences from standard stock options and we shall discuss all these and more in this tutorial.

Why Trade VIX Options?

VIX options make the trading of the movements in the CBOE VIX possible. The CBOE VIX rises when volatility in the market rises and falls when volatility in the market falls. The VIX made a commodity out of volatility, which used to be only an abstract concept, and the VIX options gave traders the key to making money from this new commodity. As such, traders are now able to speculate on and profit from their expectations of future volatility through buying VIX call options or VIX put options. In fact, more complex options strategies such as Bull Call Spreads and Condor Spreads can also now be used to profit from expectations of future volatility. As the VIX has a negative correlation with the major market indices, VIX call options can also be used as a hedge against sudden market plunges.

The other way of trading the VIX is through the CBOE Volatility Index (VX) Futures.

VIX Options Specifications

Underlying Symbol: VIX (non deliverable)

Lot Multiplier: $100

Strike Price Intervals: 1) $0.50 where the strike price is less than $15, (2) $1 where the strike price is less than $200, and (3) $5 where the strike price is greater than $200.

Expiration Date: Third Wednesday of the month

Exercise Style: European

Settlement Style: Cash Settled

Trading Hours: 8:30 a.m. to 3:15 p.m. Central Time

Differences Between VIX Options & Standardized Stock Options

From the above specifications for VIX options, it is clear that VIX options differ from standardized stock options in terms of expiration date, exercise style as well as settlement method. Standardized stock options expires every third Friday of the month while VIX options expires every Wednesday of the month, which is exactly 30 days before the third Friday of the following month. Stock options are American Style Options which can be exercised anytime before or during expiration but VIX options are European Style Options which can only be exercised during expiration. This makes the premium of VIX options lower than American Style Options. While you can exercise stock options to take delivery of the underlying stock, VIX options can only be exercised for cash delivery based on the difference between the index and the strike price.

Using VIX Options In Conjunction With Options Strategies

Many volatile options strategies such as the Long Straddle and the Long Strangle depends on rising volatility in order to ensure profitability. If implied volatility in the market drops, what we call a "Volatility Crunch", these volatile options strategies may not profit even if the underlying asset moves strongly. With VIX options, VIX put options may be bought in conjunction with these volatile options strategies so that losses occurring from a reduction in implied volatility would be offset by the gains in the VIX put options as the VIX falls. This forms a hedge against volatility for options strategies sensitive to volatility. Similarly, options strategies sensitive to rising volatility, such as the Short Straddle, could similarly be hedged by buying VIX call options.

Volatility Speculation Using VIX Options

VIX options make speculation on the future movements of the VIX a very simple matter. Even though the VIX is an index, it is also some what of an oscillator which trades within a range of between about 10 to 50. This is because it cannot go down to zero as that would imply that the market would remain totally still for the next 30 days and it cannot go above 50 for any significant length of time because that would imply an unusually high market gain or loss over the next 30 days. Speculators could perform bullish options strategies such as the bull call spread using VIX options when the VIX is at or around 10 and switch to bearish options strategies such as the bear put spread when the VIX is high.
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