The VIX is a volatility index that measures that measures elasticity of front month options on the Standard & Poor?s 500 Index (SPX).
It is a proprietary trading vehicle created by the Chicago Board of Options Exchange (CBOE). The futures were added in 2004 as a complimentary trading vehicle to the existing options which immediately began to gain in popularity. Today the VIX are known for the ability the hedge a portfolio by utilizing a series of strategies based upon the risk scenario in question at any given point in time.
In that the VIX measures short term changes in volatility understanding how and why to trade the product is essential to utilizing the options in the most efficient manner to achieve the investors goals. The VIX is not an index for all. Even though it reflects volatility in the market at any given point, trading the options should be carefully studied before committing to a position.?
The options on the VIX
How to effectively trade the VIX: Spreads that one might consider are:
Single Options: Options bought on individual strikes in specified months. In the VIX this strategy is somewhat less desirable than it is for other trading vehicles. Generally, when trading call options on the VIX it is best to sell a call on a higher strike to hedge the cost of the long call due to the fact the positions tend to be shorter term in nature. ??
Call Stupid?s: Two separate calls bought on separate strikes in the same month.
VIX trading at 12.50
??????????????????? Example: Buy 10 September calls on the 14 strike for .70
???????????????????????????????????? Buy 10 September calls on the 15 strike for .35
The reason behind call stupid spreads is the trader enjoys a reduced price on the higher strike (or lower strike in the case of a put stupid). Should the SPX drop the index could easily move up with both strikes ending up in-the-money (ITM).
Vertical Spreads: Long a lower strike and short a higher strike to help finance and reduce the cost of buying the initial long call. As explained above, vertical spreads are directional in nature. Long a call vertical in the VIX options. The same can be done when the market is basing after a drop in the SPX, the investor is looking to protect against a down move in the markets which tends to drive up volatility, buying a put spread or selling a call spread can gain a return on capital as the market begins to appreciate.?
Call or Put Condors: These spreads are comprised of a long vertical coupled with a short vertical which widens out the target area. The condor is simply a way of utilizing a short vertical to help finance a long vertical on lower strikes.
VIX trading at 13.00
????????????????????? Example: Buy 10 September 15 calls for 1.05
?????????????????????????????????????? Sell 10 September 18 calls for .50??????????????
??????????????????????????????????????? Sell the September 23 calls for .30
??????????????????????????????????????? Buy the September 26 calls for .10
By utilizing the short vertical, the cost of owning the long call vertical is reduced by an additional .20 while still affording the investor to take advantage of an upward move in volatility to between 18.35 to 22.65.
Other spreads that are beneficial to understand are:??
Diagonal Spreads: Long a front month call and short a back month call at a higher strike.
Calendar Spreads: Long a front month call and short a back month call in order to reduce the cost of owning the long call in the front month.
On average a portfolio of $100,000.00 can expect to hedge with is based on the delta in relation to the VIX as well as the cost of the hedge. To hedge 10% of the portfolio with an option with a delta D of say .50, the investor could expect to need 250 or so calls or combination of spreads to properly hedge that portion of the respective portfolio. In addition, futures on the VIX are an excellent way to hedge especially due to the fact they trade 24 hours and often reflect overseas sentiment and reaction to world events taking place while US markets are closed. The VIX should be studied careful to gain a better understanding of the inverse relation between the SPX and VIX.