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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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