Table of Contents
What Is a VIX Option?
Let me explain what a VIX option is directly: it's a type of non-equity index option that relies on the Cboe Volatility Index as its underlying asset. You need to know this if you're looking into volatility trading.
Key Takeaways
- VIX options trade with the S&P 500 Volatility Index as their underlying.
- VIX call options make a natural hedge against downward price shocks.
- VIX put options can be problematic because the S&P 500 index does not often rise rapidly.
- VIX options trade as European-style options.
Understanding VIX Options
You can trade both call and put VIX options. The calls help hedge your portfolios against sudden market declines, while the puts can hedge against rapid reversals of short positions on the S&P 500 index. These options let you speculate on future volatility moves.
The VIX option started in 2006, marking the first time individual investors could trade on market volatility through an exchange. If you're an investor, trading VIX options can be a useful tool. Buy a VIX call option, and you can profit from a rapid volatility increase.
Sharp volatility spikes often align with short-term stock price shocks. Volatility rises frequently, though not always, during downward market trends. This makes VIX call options a natural hedge, one you can use strategically over longer periods or tactically in the short term. In many scenarios, it's more efficient than equity index options.
The VIX tends to decline slowly but increase rapidly. That's why well-timed VIX call options work as an effective hedge, but VIX put options are tougher to use right. Puts can pay off if you correctly predict a market shift from downtrend to uptrend.
VIX options settle in cash and follow the European style, meaning you can't exercise them until expiration. You can always sell a long position or buy to close a short one before that.
If you're an advanced options trader, you can apply strategies like bull call spreads or butterfly spreads with VIX options. Just note that calendar spreads might not work well because expiration series don't track each other as closely as in equity options.
VIX Explained
The Cboe Global Markets Volatility Index trades under the symbol VIX. But it's not like other instruments you might trade. Instead of tracking a commodity price, interest rate, or exchange rate, the VIX reflects the market's expected 30-day volatility in stocks.
It's a calculated index derived from S&P 500 options prices. The VIX estimates volatility from now until those options expire. The Cboe aggregates prices from multiple options to create this volatility value that the index follows.
Launched in 1993, the VIX originally measured implied volatility of eight S&P 100 at-the-money puts and calls. By 2004, it expanded to the S&P 500 for a broader, more accurate view of future volatility expectations. VIX levels above 30 signal high volatility from investor fear or uncertainty, while below 15 indicate calmer, even complacent markets.
Due to its sharp rises during market fear and uncertainty, people call the VIX the 'fear index.' That's a key point to remember when you're considering volatility trades.
Other articles for you
A banker's acceptance is a bank-guaranteed payment instrument used in international trade to minimize risks for both buyers and sellers.
A zone of support is a price area where a security's value is predicted to stop declining and potentially reverse or continue its trend.
Garage liability insurance provides specialized coverage for automotive businesses against bodily injury and property damage from daily operations, distinct from garage-keepers coverage and other business insurances.
A Lost Policy Release (LPR) is a document that releases an insurance company from liabilities when a policy is lost, destroyed, or canceled.
Discretionary investment management involves a portfolio manager making investment decisions for clients without needing their approval for each transaction.
A tax deductible is an expense subtracted from adjusted gross income to reduce taxable income and taxes owed.
The last mile refers to the final, often complex and costly stage of delivering services or products to end customers in dense areas.
The equity method is used by companies to account for investments where they have significant influence but not control over another entity.
Neoclassical economics focuses on how consumer perceptions of utility drive prices and market dynamics, assuming rational decisions and self-regulating markets.
Online shoplifting is the theft of goods from online merchants through methods like fraudulent chargebacks or illegal downloading of copyrighted content.