vix options/futures

Maverick74 · Oct 17, 2006

Quote from jj90:

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.
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It's not a straight arb. There is a white paper on the CBOE web site that explains how the vix options are priced off the spx options.

Maverick74 · Oct 17, 2006

Quote from jj90:

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.
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There are a lot of holes in the post. When I have some time, I'll try to pick it apart for you. I'm really busy at the current time but I'll try to get to it later in the week. Don't feel bad though, most people don't understand the product.

jj90 · Oct 17, 2006

Mav, what I mean VIX vol vs SPX vol is that since the VIX options are priced off the VIX futures which are priced off the SPX options, if the VIX option vol for example for the near month is say 20 because of huge buying, when the near month futures is showing SPX option vol is 12, you can sell options on VIX and buy options on SPX. That looks like arb to me, since the VIX futures have no carry and thus no premium. I apologize in advance if this post is just a repeat of my previous one. I do admit my ignorance on the subleties on VIX.

MTE · Oct 17, 2006

Quote from jj90:

Mav, what I mean VIX vol vs SPX vol is that since the VIX options are priced off the VIX futures which are priced off the SPX options, if the VIX option vol for example for the near month is say 20 because of huge buying, when the near month futures is showing SPX option vol is 12, you can sell options on VIX and buy options on SPX. That looks like arb to me, since the VIX futures have no carry and thus no premium. I apologize in advance if this post is just a repeat of my previous one. I do admit my ignorance on the subleties on VIX.
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OK, I'm no expert on VIX futures/options, so feel free to correct me, but as far I know VIX futures/options are priced off the variance swap, which means that it's not that simple to exploit any arb opportunities.

riskarb · Oct 17, 2006

Quote from MTE:

OK, I'm no expert on VIX futures/options, so feel free to correct me, but as far I know VIX futures/options are priced off the variance swap, which means that it's not that simple to exploit any arb opportunities.
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They are. The atm straddle should be in-line with a var-swap of the same-duration. The var-swap was under the atm vix straddle last time I checked, apparently due to the method by which the vol-surface is calculated under VIX.

The synthetic VIX is currently priced at 12.80% with the VIX cash at 11.53%.

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vix options/futures

Maverick74

Maverick74

jj90

MTE

riskarb