The S&P 500 VIX Futures Series is a collection of investable indices that aim to simulate the outcome of having a long position in VIX futures contracts and allow investors directional exposure to volatility through publicly traded futures markets.
What can we learn from the VIX?
The Cboe Volatility Index (VIX) is generally known as the “Worry Index” because it measures the level of fear or stress in the stock market using the S&P 500 index as a proxy for the entire market. The higher the VIX, the more fear and uncertainty there is in the market, with levels exceeding 30 signaling extreme fear and uncertainty.
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) increments. 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.
What is the relationship between the VIX and the S&P 500?
VIX futures and options, for example, are frequently groundbreaking products with distinctive qualities that appeal to market participants. Volatility exposure has evolved into a new asset class in several ways. By definition, volatility is directionally neutral, with upper and lower boundaries, as well as other characteristics that may enable distinct investing strategies and possibilities.
In general, the VIX Index and the S&P 500 Index have an inverse connection. Because of this negative association, the VIX Index has gained the moniker “fear gauge,” as it has a tendency to rise quickly when the broad market falls rapidly.
When markets are volatile or the economy is in trouble, expected volatility rises. When stock prices rise, on the other hand, the VIX Index tends to decline or remain stable at the low end of the spectrum. Cboe is the source of this information.
Because the VIX Index has an inverse connection, tradeable futures and options contracts could be useful risk management or hedging tools. During periods of significant macro stress, the negative correlation tends to improve (become more negative) (e.g. 2008 and 2020).
What exactly is the distinction between VIX and VIX?
VXX (ETN) and UVXY (ETF) are both exchange-traded funds that track the daily percent return of a portfolio of two front-month VIX futures contracts. UVXY differs from VXX in that it is two times leveraged. This indicates that on any given day, UVXY will return twice the percentage of VXX.
How do you interpret the VIX?
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.
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.
What does it signify when the VIX is negative?
When the VIX is low, what does it mean? When the VIX is low, it indicates that the market is less fearful, that there is greater stability, and that long-term growth is possible. The VIX has a negative correlation with the S&P 500, which means that when the VIX is low, the S&P 500 is usually rising in price.
VIX futures are traded on what exchange?
VIX futures were first traded on the Cboe Futures ExchangeSM (CFE) in 2004. They allow market participants to trade a liquid volatility product based on the VIX Index methodology. VIX futures reflect the market’s prediction of the VIX Index’s value at various future expiration dates. VIX futures give market players a number of ways to put their ideas into action through volatility trading tactics such risk management, alpha generation, and portfolio diversification.
What effect does VIX have on spy?
Volatility is thought to diminish during a bullish market period and increase during a bearish one. Even on a daily basis, CBOE statistics show that if $SPX swings one way, $VIX moves the other 75% of the time. When longer periods of time are taken into account, the percentage changes (see page two for exact statistics). Despite the fact that $SPX is blowing out to the upside, $VIX has recently began to rise. This is an odd action, which we will attempt to investigate in this essay.
The movements of the $VIX futures are, of course, strongly tied to the movements of the $VIX, therefore they will be discussed as well. Finally, we’ll be using the data from the feature piece from three issues ago (“Large Differences In Historical and Implied Volatility”).
We’ve been writing about these and related themes on a daily and weekly basis for a while now, but since the time frame that’s essential to the entire volatility derivatives spectrum – the fall of this year is rapidly coming, we thought it’d be useful to compile everything in one spot.
$VIX and $SPX movements
The fact that $VIX and $SPX move in opposite directions is something we commonly mention without verifying. So, in order to address this, we conducted a study on our database, and the following is what we discovered.
One Day Move: $VIX opposite to $SPX 78% of the time
We did this research over the course of 4160 trading days (from 1/28/1993 to 7/31/2009), comparing changes in $VIX to changes in $SPX. On the rare occasions when both were up or down on the same day, they were in the minority. We discovered that $VIX moved in the opposite direction of $SPX1 on 78% of trade days. This is a little more than the average “They are close enough to conclude that the fact that they travel opposite to each other on a daily basis is generally true, according to the “75 percent” statistic that is often recognized. The frequency increases for longer periods of time, according to popular belief. Our research, on the other hand, contradicts this. In the 3-day research, for example, we compared each index’s close to where it closed three days previously. It was regarded an anomaly if the two moved in opposing directions from close to close over a three-day period “move in the opposite direction”
This seemed almost counter-intuitive to me, so I dug deeper into the data. Let’s take a look at the 20-day moves. You’d imagine that any increase in $SPX would be accompanied by a move in $VIX in the opposite direction over the course of 20 trading days (almost a calendar month). In reality, if $SPX made a significant move, this was always the case. If $SPX was merely roaming around, then $VIX was doing the same, and the results appeared to be random.
Consider the period from May 8 to June 19, 2007, which encompassed 30 trade days. Only eight occasions (out of 30) did $VIX move in the opposite direction of $SPX throughout those 30 days when compared to their antecedent from 20 days prior. What was going on at the time?
During that 30-day period, the $SPX was relatively stable and non-volatile. It has been gently creeping higher for the previous twenty days. Meanwhile, $VIX was doing roughly the same thing, gently climbing higher in April before flattening out in May. The fact that $VIX was gaining throughout May while the $SPX was falling was most likely due to $VIX’s long-term low. However, in February 2007, when the US markets saw a dramatic but brief fall and the Chinese market plummeted, $VIX exploded skyward. Following the explosion, traders steadily increased $VIX over the next few months, finally leading to the bear market, which began in August of that year with the subprime loan crisis.
Furthermore, the fact that the $SPX was trendless in May 2007 contributed to the “opposite” indicator’s low “score.”
In any event, we can confidently assert that $VIX and $SPX move in opposite directions approximately 75% of the time, spanning periods of 20 days or less.
Recently, there has been some talk in option-oriented groups regarding $VIX rising at the same time as $SPX (it’s up from 23 to over 26 since July 24th). Yes, the $SPX has been marginally higher since July 24th. On a day-by-day basis, though, $VIX has moved with $SPX three times in the last eight days not a lot, but enough to raise some questions throughout the full period.
As we analyze the techniques surrounding $VIX and SPY options, keep these numbers and data in mind.
The $VIX/SPY Hedged Strategy
We’ve talked about this so much in the past that I’ll just summarize it here for completeness and to allow newer subscribers to catch up.
We’ve observed that a hedged strategy is feasible when the difference between $VIX and its near-term futures price is considerable (say, more than one point). This method has yielded a wide range of results, but it has been very profitable overall.
a) Buy calls on both $VIX and SPY if $VIX futures are trading at a significant discount to $VIX.
Alternatively, if $VIX futures are trading at a significant premium to $VIX, buy options on both $VIX and SPY.
It’s important to remember that $VIX options are reliant on the price of $VIX futures as their underlying, as this is critical to the strategy’s potential profitability.
By expiration day, $VIX and the futures must have converged in price. Prior to expiration, the convergence normally occurs, and it is often $VIX that moves to the futures price that causes the convergence. If this occurs, the $VIX side of the transaction will not gain or lose much because the futures will remain largely stable as $VIX moves to them. If the $VIX fluctuates, the $VIX option prices will fluctuate as well.
Ironically, the price of $VIX is essentially meaningless information when it comes to the pricing of $VIX options.
However, the price of SPY options will almost certainly be affected by changes in the $VIX index. According to the information offered previously, if $VIX moves higher, there is a 75% likelihood that SPY will move lower and vice versa. If the strategy is formed with a premium on $VIX futures, then puts are purchased on both $VIX and SPY. If $VIX rises to meet the futures, SPY will most certainly fall, resulting in a profit on the SPY puts.
However, when SPY does not move (about 25% of the time), the $VIX futures will move to meet $VIX since convergence must still occur. If we buy puts on both $VIX and SPY and the $VIX futures start at a premium, the $VIX futures will decrease to match $VIX. Because the underlying (futures) fell in value, the $VIX puts would profit.
When $VIX futures are trading at a discount, the strategy suggests purchasing calls on both $VIX and SPY.
Another advantage of the hedged position is that it does not require convergence to profit if the markets become extremely turbulent. We bought calls on $VIX and SPY in the fall of 2008, for example, because the $VIX futures were at a discount. The markets then crashed, sending $VIX soaring. Even if $VIX and its futures varied, it didn’t matter. The $VIX calls were making a lot of money, whilst the SPY calls were only able to lose their initial, fixed amount. Even if the prices diverged, a profit was made.
September futures are currently trading at a significant premium to $VIX, necessitating the use of a hedged strategy involving the purchase of options on both (more about that later).
Actual Volatility
We examined the fact that actual volatility of the $SPX was fairly low compared to $VIX three issues ago (Vol. 18, No. 12), and then the $VIX futures were at an even greater level. When $VIX futures trade at a level 10 points higher than the $SPX’s 20-day statistical volatility, we believe the market is going to make a significant and/or volatile move. The last time this happened was in late June, and since then, $SPX has soared by 80 to 100 points.
The 20-day historical volatility of the $SPX has now decreased to 16%! Aside from the other factors, this is nearly unbelievable. This recent bull run’s daily movements have been so consistent that actual volatility is plummeting like a rock (for comparison, the 10-day historical is 14 percent ; the 50-day historical is 21 percent and the 100-day historical is 28 percent ). You might be wondering why “Traders” appear to have become so complacent that volatility has been driven to these low levels. These data, on the other hand, have less to do with traders’ perceptions of volatility and more to do with how volatility is computed. 2
The September, October, and November futures are all trading above 28, indicating that market conditions are favorable “Volatility” (a difference of more than 10 points between futures and 20-day historical) is still fulfilled. Another huge, turbulent market move is expected to start soon.
Why The Large $VIX Futures Premium?
Since mid-June, $VIX futures premiums have been exceptionally high, reaching highs of over 5.00 points last week before $VIX rebounded. Historically, such high premiums have signaled a market downturn, but that hasn’t been the case this time (at least not yet, and given the current move’s strength, it’s hard to imagine it unraveling anytime soon).
In light of these data, it appears to me that in the past, futures premiums and discounts particularly premiums were the product of market forces “Wise money.” A tiny group of savvy traders were able to forecast periods of extreme volatility when others weren’t anticipating it. Purchasing SPY options outright was a winning approach at the time.
However, at this moment, it appears that a consensus belief is that considerable volatility will occur in September, October, and November (and possibly even into December). Everyone is worried about what the market will do in the fall, so they’re buying puts. That doesn’t seem like smart money to me, but rather a point of view that contrarians should consider “Fade”
This, in our opinion, is an even stronger argument for why the hedged strategy is superior to buying SPY puts outright.
Summary
So it pretty much sums up the current state of volatility. Because many traders expect the October-November season to be tumultuous, $VIX futures prices have risen. Actual market movements, on the other hand, have overlooked this potential issue, driving volatility down throughout this bullish era. The market is most likely poised for another wild ride, but the direction is undetermined. So, at this time, the $VIX/SPY hedged put strategy is the best bet, because it can profit from a wild move in either direction, and it already has the “advantage” of pricey $VIX futures. A recommendation can be found on page 12.