If you want to trade options on fear there are few things you should know:
- Your brokerage account needs to be a margin account, and you need to sign up for options trading. There are various levels of option trading available (e.g., the first level allows covered calls). My experience is that to trade VIX options you will need to be authorized to trade at the second level. These levels vary from brokerage to brokerage, so you will have to ask what is required to be long VIX options. If you are just getting into options trading this is as high as you want to go anyway. Selling naked calls for example is not something for a rookie to try.
- No special permissions are required from your broker for VIX options. In general the same sort of restrictions (e.g. selling naked calls) that apply to your equity option trading will apply here.
- Calendar spreads aren’t allowed (at least within my account, with my level of trading). The software didn’t prevent my entering the order, but the order was cancelled once I entered it and I got a call from the broker–ok, what did I do now? The reason for this restriction is because the options from different months don’t track each other well. More on that later.
- The option greeks (e.g. Implied Volatility, Delta, Gamma) that are normally quoted are wrong. Most calculations assume the VIX index is the underlying security for the options, in reality the next to expire volatility future contract is the underlying. To compute the correct greeks yourself go to this post.
- Because the underlying for VIX options is the futures contract, the options prices do not track the VIX especially well. A big spike on the VIX will be underrepresented, and likewise a big drop probably will not be followed especially close either. This is huge deal. It is very frustrating to predict the behavior of the market, and not be able to cash in on it. The only time the VIX options and VIX are guaranteed to line up is on the morning of expiration.
- The VIX options are European exercise. That means you can’t exercise them until the day they expire. There is no effective limit on how low the prices can go on the VIX options until the exercise day.
- Expiring In-the-Money VIX options give a cash payout.
- The expiration or “print” amount when VIX options expire is given under the ^VRO symbol (Yahoo) or $VRO (Schwab). This is the expiration value, not the opening cash VIX on the Wednesday morning of expiration.
- VIX options do not expire on the same days as equity options. It is always on the Wednesday, before or after the equity options. See this post for upcoming expirations. Since the VIX is derived from SPX index options having the two options types expiring on the same day would have been asking for trouble.
- The bid-ask spreads on VIX options tend to be very wide (e.g., 0.5) . I believe this is because it is difficult for the market makers to hedge their positions. I have always been able to do at least .1 better than the published prices–always use limit orders. If you have time start halfway between the bid-ask and increment your way towards the more expensive side for you.
- I don’t recommend you start trading options on VIX if you aren’t an experienced option trader. If you are a newbie trade something sane like SPY options first…
- The VIX is not like a stock, it naturally declines from peaks. This means its IV will always decline over time. VIX options as a result will often have lower IVs for longer term options–not something you see often with equities.
- The CBOE reports that trading hours are: 7:30am to 4:15pm Eastern time, but in reality the options do not trade until after the first VIX “print”-when the VIX value in calculated from the first SPX options transactions. The first VIX quote of the day is usually at least a minute after opening.
