VIX futures are contracts based on the CBOE Volatility Index, also known as the VIX and dubbed “the Fear Index” since it tends to increase when equities fall and investors become afraid. The CBOE Volatility Index gauges the implied volatility of S&P500 stock index near-term options.
By CFE
Volatility has emerged as an asset class over the last decade, with VIX Futures leading the way. In 2004, the CBOE Volatility Index (VIX) was used to launch financial futures trading. This was the first time a publicly traded derivative that allowed investors direct exposure to projected market volatility was accessible for trading. If you’re thinking about adding volatility to your trading and portfolio management toolbox, there are a few things to keep in mind before you get started.
What Does the CBOE Volatility Index (VIX) Indicate?
VIX is a standardized measure of near-term volatility based on option pricing for the S&P 500 (SPX).
The VIX is calculated using two separate expiration sets of SPX options, with the two series being time weighted to produce a consistent 30-day measure of implied volatility.
When the S&P 500 is under pressure, the demand for SPX put options rises, causing VIX to rise.
Because of the heightened demand for portfolio protection when the market is under pressure, VIX has earned the moniker “The Fear Index.”
2. The VIX Index and the S&P 500 Index
Traders have been trained to believe that when the S&P 500 falls, VIX increases, and when the S&P 500 rises, VIX falls. This view has some merit because the long-term daily price change connection between the S&P 500 and VIX is extremely close to -0.75. On occasion, though, both the S&P 500 and the VIX move in the same direction. In fact, VIX and the S&P 500 price moves move in the same direction on around 20% of trading days. From January 2004 through July 2016, the table below shows the link between VIX and the S&P 500 on days when equities were higher and days when they were lower.
From August 2015 to July 2016, the daily price action in the S&P 500 and VIX is seen in the chart below.
There have been a few instances where the S&P 500 has dropped off sharply, and VIX has surged in reaction.
Contract Specifications for VIX Futures
A VIX Futures contract has a notional value of $1000 times the index. Futures trade in 0.05 or ($50 a tick) increments, but calendar spreads may be quoted in 0.01 ($10 a tick) intervals. In June 2014, the trading hours for VIX Futures were extended to nearly 24 hours a day, five days a week. Spot VIX is calculated and quoted outside of US trading hours, starting at 2:15 a.m. Chicago time, which is when European markets open.
The CBOE Futures Exchange has been listing VIX Futures expiring each week for multiple weeks in a row for just over a year.
There are also regular VIX Futures contracts that expire every month.
Standard expiration is usually on a Wednesday, which is 30-days before the standard third Friday SPX option expiration date the following month.
The VIX futures quotes from August 15, 2016 are shown in Figure 2.
VIX Weeklys Futures and regular VIX futures are used in the above quotes.
The VIX/Q6 contract is the typical VIX contract for August.
The quotes that start with a number are VIX Weekly Futures, and the numbers denote the week in which these contracts expire.
VIX futures are contracts that are settled in the morning.
The final settlement value for VIX Futures is the VIX Index’s Special Opening Quotation (SOQ). The SOQ is derived from the opening prices of constituent SPX or SPX Weeklys options that expire 30 days following the VIX expiration date. The ticker VRO is used to communicate the final settlement value for VIX futures. The day before settlement is the last trading day for VIX Futures, thus a contract that is set to expire on Wednesday morning will stop trading at 3:15 p.m. Chicago time the day before settlement. This means that on the day of settlement, a contract slated to expire will not trade during non-US hours.
Spot VIX and other VIX futures may trade at a premium or discount to VIX Futures contracts.
The majority of trading days, VIX Futures are trading at a premium to spot VIX as well as futures contracts that expire before the particular contract’s expiration date.
The pricing of spot VIX and regular VIX futures contracts on the Friday before and after the recent Brexit vote is shown in Figure 3.
RISK DISCLAIMER: Trading futures products carries high risk of loss, which must be acknowledged before trading and may not be suitable for all investors. Actual trades or methods referenced above may have performed well in the past, but this does not guarantee that they will perform well in the future. Phillip Capital Inc. bears no responsibility for errors or omissions in the material included herein, which is supplied to you solely for informational purposes and is believed to have been derived from reliable sources but cannot be guaranteed. The author’s thoughts and opinions in this letter are his or her own and do not reflect those of Phillip Capital Inc. or its employees.
How are VIX futures determined?
The VIX is derived by multiplying the number of days in a month by the number of days in “By averaging the weighted prices of out-of-the-money options and calls, you may compute predicted volatility.” In the example below, we’ll start on the far left of the formula with options that expire in 16 and 44 days, respectively. On the left, there is a symbol ” symbolizes the result of multiplying the square root of the sum of all the integers to the right by 100.
Is it wise to invest in VIX futures?
We feel we have discovered a hedging vehicle that provides us with the best of both worlds: protection when we need it and the chance to profit from the bull market’s continuation. The VIX futures, which are traded on the CBOE, are that vehicle.
The Chicago Board Option Exchange (CBOE) Volatility Index is denoted by the sign VIX. It reflects investors’ 30-day consensus assessment of the future and gauges the anxiety embedded in options traded on the S&P 500 (SPX). S&P 500 puts give the buyer the option, but not the duty, to sell the S&P 500 Index at a predetermined price for a set period of time.
Investors are willing to pay extra for put option protection if they are concerned. The larger the premium, the higher the implied market volatility in the price of S&P 500 options. This is what the VIX index is based on.
Because fear is the most powerful human emotion, it’s only natural that VIX would rise and fall in lockstep with fear. When investors foresee large market declines, VIX rises, then falls as the fear of those declines fades. The relationship between the two may be seen clearly in the “The “Monthly VIX” chart is shown below.
Volatility, as measured by VIX, soared from just under 15% to 89 percent in just five months during the Lehman crisis. This was accompanied by a 58 percent drop in the S&P 500. (As an example, see “Below is a chart of the “E-Mini S&P 500 Futures.” During the stock market’s 17.6% loss in 2010, VIX skyrocketed to almost 45 percent, and made a nearly identical swing when equities fell 22.3 percent in 2011.
Notice how VIX tends to oscillate in a well-defined range, from around 9% to around 45 percent ignoring the massive jump in volatility following the Lehman Brothers collapse. Because VIX tends to move in the opposite direction of stock prices, purchasing VIX at the low end of this range can be an useful hedging strategy. A brief look at these two graphs reveals that it does.
Observe how the VIX index climbs when the stock market falls and declines when the stock market rises. The fact that VIX tends to decrease more slowly during good times is part of what makes it an effective hedge. VIX’s adaptability as a hedge is aided by the fact that it reflects fear rather than a fixed price level.
Long VIX futures, especially those acquired at the lower end of VIX’s historical range, can be just as effective as a hedge against rising stock market levels. Take a look at the two most recent corrections, in 2010 and 2011, both of which saw VIX jump above 45.00 percent, despite the fact that the 2011 decline started at a higher level.
Is it time to buy when the VIX is high?
“If the VIX is high, buy” indicates that market participants are overly negative and implied volatility has reached its limit. This indicates that the market will most likely turn bullish, with implied volatility returning to the mean. The greatest option strategy is to be delta positive and vega negative, which means that short puts are the best alternative. Positive delta just means that if stock prices climb, so does the option price, and negative delta simply means that a position gains from lowering implied volatility.
Which ETF tracks VIX the most closely?
The iPath S&P 500 VIX Short-Term Futures ETN is one of the most popular VIX ETFs (VXX). This product has a long position in daily-rolling VIX futures contracts for the first and second months.
What is quad witching day, and why is it celebrated?
Quadruple witching occurs when four different sets of futures and options expire on the same day in the financial markets.
Futures and options are derivatives that are tied to the price of underlying stocks. Traders must close or change positions when derivatives expire. This can result in a large increase in volume and order flow. The following are the four types of derivatives that will expire on quadruple witching:
Note that some lists of quad-witching expirations include single-stock futures. However, these are little items that have a minor impact on the market.
Does VIX trade around the clock?
Cboe Options Exchange has increased global trading hours (GTH) for S&P 500 Index (SPX) and Cboe Volatility Index (VIX) options to nearly 24 hours a day, five days a week. Easily trade or hedge broad U.S. market and worldwide equities volatility from anywhere in the world, at any time of day or night.
What’s the distinction between VIX and VXX?
The VIX, or Chicago Board Options Exchange Volatility Index, is the basis for the VXX ETN. By analyzing current prices for put and call options connected to the widely followed index, the VIX represents investors’ views about the S&P 500’s short-term path. The VIX generates an informed forecast as to how much the index will change in the next 30 days. Traders who want to profit from market volatility bets might consider the VXX.
What does a high VIX mean?
A VIX number below 20 indicates a perceived low-risk environment, whereas a reading above 20 indicates a period of increased volatility.
Because it surges during market upheaval or periods of great uncertainty, the VIX is commonly referred to as a “fear index.” The VIX, for example, peaked in the fall of 2008, during the height of the global financial crisis, reaching beyond 80 by the year’s end. From mid-September 2006 to the end of February 2007, when markets were performing strongly, it remained below 13.5.
A low VIX reading is regarded by some contrarian investors as a pessimistic indication, signaling market complacency that may portend bad news ahead, while a high VIX reading is regarded as a positive signal by others.
However, research shows that stock markets perform better in the aftermath of low VIX values than in the aftermath of high VIX readings.
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What does a normal VIX value look like?
The VIX tries to predict future volatility for the next 30 days, but it isn’t very accurate. A VIX of 25 does not always imply that volatility will average 25% over the next month or so. According to studies, the VIX tends to overestimate volatility by 4 or 5 percent on average. However, research have shown that the VIX has some predictive validity. Here are some basic rules for interpreting the VIX level in terms of future volatility:
- When the VIX is between 0 and 12, volatility is predicted to be minimal. In November 2017, the VIX had its lowest daily closing value of 9.14.
- VIX 13-19: This range is considered normal, and volatility over the next 30 days is predicted to be normal when the VIX is at this level.
- When the VIX reaches 20 or higher, you can expect higher volatility than usual over the next 30 days. This level is usually reached during periods of market stress, such as when fears of an economic downturn or recession are present. The VIX can reach 50 or higher during major market shocks like the financial crisis or the emergence of a global epidemic.
Unexpected occurrences can throw markets for a loop, and a low VIX number today could be followed by a period of significant volatility if conditions shift.