Some Observations on the VIX

Some observations on these Options

Most brokers have the ability to trade these options now.but they are still somewhat obscure.It took me a long time to figure out the symbol to even get Quotes.For example at Schwab it is $vix.The Options trade only on the CBOE.There are actually three variants of these indexes but options are only available on the VIX (which covers the SP500) at this time.You would need a futures account to trade the underlying index(s).The options are nicely set up in mostly $1 increments(10c11c12c;10p,11p,12p;etc.)and multiple expirations into the future.I noticed that price changes in these options lag the movement in the S&P 500 .But this makes sense since these are a derivitive on a derivitive on a derivitive.In other words;the S&P is based on the 500 stocks in the index,the option prices are derived from the underlying stocks.And the VIX is based on the buying selling,and pricing of the options.Seems like there is a lag while the investors buy or sell the options in reaction to the S&P movement,which shows up somewhat later in the VIX index.
investors who had bought call options on the vix index when it was around 10 made a killing last week.
i noticed some some strange pricing of “in the money” options on the VIX so I thought I would check further.”In the money” options usually trade for at least the difference between the strike price and the underlying stocks(or index) current price.The Vix options do not always do this.This is because they cannot be exercised until the date of expiration at which point they are settled for cash(sometimes called euro style).At that date, if you were long a call that was in the money by 1 cent or more,an automatic assignment would occur;you would receive the difference between the closing price of the expiration months future contract (which would mirror the index),and the strike price of the call that you held.Incidentlly,VIX options do not expire on the third friday of the month like stock based options.They expire 1 month prior to the next months futures contract expiration,about 3 trading days after that 3rd. friday(there is a exp. calender on the cboe site).So these options will tend to trade on investor expectations of where the VIX will trade on expiration day;where it will “end up” ;not so much where it is on any given day, in the options life ,thru the month.This tendencey would open some tantalizing possibilities for a speculator with a strong opinion on where the index would end up.For example as of the date of this story,(3/4/07)”In the money” March 07 14 VIX calls,were at $2.3 around the close.The VIX index closed at $19.63.Therefore this option HAD AN INTRINSIC VALUE OF $5.63;but was selling @$2.3!.What about the time value with 2 weeks left? 0; nada!!!Obviously many traders believe that the index will close at more like $16.3(14+2.3).But if the index closed on march 21 (expiration day)at $19.63 ;right were it is today,you would receive $5.63 for your $2.3 option!!!!These kinds of large distortions don’t occur in stock based options ,since arbitrage exists..they simply request assignment of the underlying stock and “soak up” any discrepancy between the option price and the underlying stocks price.You would need to have a futures account to take advantage of arbitrage between these unusual options and the underlying security on which it is based.Evidently futures traders do not wish to bother with this
A march 10 2007 VIX call option went from $1 to $8+ in a day.So a $1000 speculation would be worth $8000.
Be clear on what you are expecting to happen if you decide to play with these options.Various scenarios would dictate different moves.If you expected a large violent move to the downside in the S+P 500,you would buy calls on the VIX.If you expected a large move to the upside you would buy puts.If you expected no change you minght sell (short)out of the money options against the index to capture the decay of the time value of the option as they expired worthless.As many hedge funds found out last week that strategy was a very risky.In the $8000 call option mentioned above,the person on the other side of that trade(that sold the call) turned a potential $1000 profit to a $8000 loss.Not for the faint of heart or wallet.There are all kinds of straddles using multiple options that can be constructed to limit risk


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