Key Takeaways
- European-style, cash-settled volatility derivatives.
- Based on 30-day forward implied S&P 500 volatility.
- Used for hedging or speculating on market volatility.
- Trades on CBOE with weekly and monthly expirations.
What is VIX Option?
VIX options are European-style derivatives that provide exposure to the CBOE Volatility Index (VIX), which measures the market’s expectation of 30-day forward implied volatility on the S&P 500 Index (SPX). Unlike direct trading of the VIX, these options are cash-settled and based on the index’s futures prices, allowing you to trade volatility without owning the underlying index.
Because the VIX reflects expected market turbulence, VIX options serve as tools for hedging or speculating on volatility changes, complementing traditional equity holdings like SPY or IVV.
Key Characteristics
VIX options have distinct features that differentiate them from standard equity options:
- European style: Exercisable only at expiration, which means no early exercise like with some call options.
- Cash settlement: Settled in cash using the Special Opening Quotation (SOQ) of SPX options, eliminating the need for physical delivery.
- Pricing basis: Prices derive from VIX futures, not the spot VIX, reflecting mean-reverting volatility dynamics.
- Contract multiplier: Each contract controls 100 times the VIX index price, amplifying gains and losses.
- Trading cycles: Available as weekly and monthly expirations, with frequent liquidity on the CBOE.
How It Works
VIX options derive value from the implied volatility embedded in S&P 500 options, aggregating expectations of market turbulence over the next 30 days. You cannot exercise them early, and settlement occurs at expiration based on the VIX’s Special Opening Quotation, which is calculated from SPX option prices.
When you buy a VIX call, you profit if volatility rises above your strike price by expiration; conversely, VIX puts gain value when volatility declines. This makes them useful for hedging against sudden spikes in market uncertainty or for volatility speculation in combination with equity products like SQQQ.
Examples and Use Cases
VIX options serve various strategies across different market conditions:
- Hedging equity portfolios: Investors holding broad market ETFs such as SPY or IVV can buy VIX calls to offset losses during equity downturns when volatility surges.
- Tail risk protection: Buying deep out-of-the-money VIX calls provides low-cost insurance against rare but severe market shocks, a concept related to tail risk.
- Volatility speculation: Traders anticipating increased market uncertainty may buy VIX calls or sell puts, profiting from volatility shifts without directly trading stocks.
Important Considerations
While VIX options offer unique exposure to volatility, be mindful that their prices reflect a volatility risk premium, often leading implied volatility to exceed realized volatility. This can cause time decay and premium loss if volatility remains subdued.
Due to their European exercise style and cash settlement, you should carefully manage expiration timing and understand that settlement is based on calculated index values rather than direct market prices. Incorporating VIX options into your portfolio alongside instruments like dark pool data or broad market ETFs can improve risk management and return diversification.
Final Words
VIX options offer a unique way to hedge or speculate on market volatility without trading the underlying index directly. To leverage their potential, compare pricing across expirations and consider how volatility forecasts align with your portfolio’s risk profile.
Frequently Asked Questions
A VIX option is a European-style, cash-settled derivative based on the CBOE Volatility Index (VIX), which measures expected 30-day market volatility of the S&P 500. These options provide a way to trade or hedge volatility since the VIX itself is not directly tradable.
The VIX is calculated using implied volatility from a wide range of SPX put and call options with near-term expirations, targeting a 30-day constant maturity. It weights options prices inversely by strike price squared and aggregates variances to estimate expected market volatility.
VIX options are European-style and settle in cash at expiration based on the Special Opening Quotation (SOQ) of SPX options. There is no physical delivery because the VIX is an index, not a tradable asset.
VIX options trade on the CBOE with weekly and monthly expirations, use a multiplier of 100, and have tick sizes depending on premium. They price relative to VIX futures, reflect volatility expectations, and are used to speculate on or hedge against market volatility.
Investors use VIX options, especially long call positions, to hedge equity portfolios against spikes in volatility and market downturns. When the S&P 500 falls and volatility rises, gains from VIX calls can offset losses in equity holdings.
VIX options usually price implied volatility higher than realized volatility because of the volatility risk premium, reflecting the market’s demand for protection against sudden spikes. This behavior creates opportunities for arbitrage strategies.
VIX options prices are based on the corresponding VIX futures prices rather than the spot VIX index. This is because the VIX futures reflect market expectations of future volatility and exhibit mean-reverting dynamics.
You can trade VIX options both weekly and monthly on the CBOE. Weekly expirations allow for more flexibility and short-term volatility trading, with up to six weekly cycles available at a time.
