Yes, that is part of the non-transparency I was referring to. VIX spot calculation is straightforward and a direct derivative of SPX implied vols. There is no room for interpretation. VIX options are a different matter. The VIX Options FAQ explains it very clearly: http://www.cboe.com/micro/vix/VIXoptionsFAQ.aspx "VIX option prices should reflect the forward value of VIX, which is typically not as volatile as spot VIX. For instance, if spot VIX experienced a big up move, call option prices might not increase as much as one would expect." The problem is, how does one arrive at a forward value for VIX? It's not simply a case of cost-of-carry. This is perhaps why Riskarb refers to these as perception trades. The VIX forward value is based on perception. Sure you can model in mean-reversion and non-lognormal distributions etc. but the forward is still a market perception. Furthermore, to price the VIX options, like other options, one needs a sense of volatility for the underlying and even have a forecast for the future realized volatility - in this case the underlying is the VIX forward, which incidentally has a different volatility to VIX spot! So, in short, the VIX options are in theory priced on the expected volatility of the forward implied volatility (vvol) of SPX options 30 days out! Clear as mud then LOL. Comprehension of this product is not an insurmountable task though. Earlier thread on VIX options that may be of interest: http://www.elitetrader.com/vb/showthread.php?s=&threadid=63150 Good luck. MoMoney.
touching on some of the notes posted. i traded the vix options before i knew how they really worked. THE MAIN THING FEW UNDERSTAND IS VIX OPTION PRICING IS BASED ON EXPECTATIONS ON FORWARD LOOKING VIX LEVELS. in july i bought some nov vix 17.50 puts as i recall for $2.50 or so when the vix was 18 or so. the vix plunged to 13.50 and my options were maybe $2.80 and were $4 in the money. i called to exercise them and was stunned to learn they were european style options and not exercisable so i was screwed. so on a 20% decline in the vix i made almost zip. so if you buy the 12.50 calls for 2 now and the market expects volatility to icnrease even if the vix goes to 16 or so you might make very little money. does anyone know how you factor in future vix moves into the option prices?
Well mo, if your asking the theo. value based of the pricing formula, I'll honestly admit I had no clue after reading the stuff off CBOE. But if your asking about fair value as per the underlying, I'd say look at the futures. Here's my original post that I wanted to present, but I didn't know if it was too convoluted. After doing some reading into how VIX really works and pricing of the VIX futures and options, it occurs to me that if one buys long term ITM puts and near term ITM/ATM calls, you have a very low risk black swan insurance/profit type trade. Let me explain how I arrived at this. Now we all know the futures/options trade not at spot price but at forward value. And the value is determined by the the imp vol of vol, essentially the value is the estimate of an future estimate. If you plot the imp vol of vol in the future you get the term structure of vol. One will notice that the near months reflect spot VIX more accurate, well you should already know that since spot VIX reflects the nearest 30 days, but you will see an upward sloping curve which levels off. Based on this, one can obviously infer that in the future, or more accurately later in the future there will be more deviation from current values but only to an amount. Just look at VIX futures prices to see what I mean. So based on that, if future VIX values converge to spot VIX values based on less volatility the closer to expiration, as it should be common sense, eventually the ITM puts will gain as the spot is lower than forward value. ITM because there is no premium in them relative to OTM/ATM. Look at 30 strike VIX puts compared to that months futures prices. Now couple that with short term ITM/ATM calls to benefit from a jump in spot VIX, the long term ITM puts will cover the short term calls. What happens when theres a jump? Ok spot VIX is 10.75, check CBOE.com, and you buy the OCT 10 strike call for 1.25, and the MAY07 30 strike put for 14. Tommorow VIX jumps to 20. Your calls are now worth 10 at expiry and close to that in real time. Remember near term options reflect spot VIX closer. Those 30 puts are worth 10. Profit > loss. Going off the term structure, the puts were based off a vol of 16, so you only really lost 4, but the calls were based off a vol of ~11. After this shock, vols will normalize back to the curve previously, and as it gets closer to expiry, you start gaining, if not, bail out. The idea is to have the puts pay for the calls while you wait for the market to be blindsided. If not, your ok. The only drawback I can see with my rudimentary knowledge so far, please pick apart my post, is if there is heavy skew between months. In index options, the deviance is little from my experience, vols in all months tend to move to move in tandem, unlike equity vols especially prior to vols. I suspect if this works it is of more use in periods of low vol since sustained periods of high vol requiring the reverse to be done is harder to come accross as per common sense and what the term structure shows. The term structure of vol is the key to this, I honestly don't have a plan if it was flat. Note: when I say term structure, think interest rates and how it moves.
Well that depends on your definition of low risk. The way i see it, you are bleeding out $2 each month for your front month ATM calls while gaining a quarter at best on your ITM back month puts. Sure, you will earn if we get a spike but at what cost?
Does anyone know when the rollover date is for VIX futures? Given the very low volume I can't figure it out from the data.....
Depends on the premium of course rally, carrying costs tied up in holding the position may be a factor too if you have size on. There are a couple of things that could go wrong, but I believe that if the put can adequately compensate the calls it is something worth exploring. Anyone have any idea on trading VIX option vol vs SPX option vol? Seems like just straight arb to me but it can't be that simple. Come on throw us a bone.