Thirteen Things You Should Know About Trading VXST options

Thursday, April 10th, 2014 | Vance Harwood

If you want to trade options on VXST I’ve listed some things below that you should know.  If you are interested in other volatility investments besides options see “10 Top Questions About Volatility“.

 Regarding VXST options:

  1. 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 VXST 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 for  long or spread positions in VXST 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.
  2. No special permissions are required from your broker for VXST options. In general the same sort of restrictions (e.g., selling naked calls) that apply to your equity option trading will apply here.
  3. Calendar spreads aren’t allowed (at least within my account, with my level of trading). The software might not prevent entering the order, but the order will be cancelled once your broker’s software gets around to analyzing the order.   The reason for this restriction is because the options from different months don’t track each other well. More on that later.
  4. The option greeks  for VXST options (e.g. Implied Volatility, Delta, Gamma) shown  by most brokers are wrong (LIVEVOL and Fidelity are notable exceptions).  Most options chains that brokers provide assume the VXST index is the underlying security for the options, in reality the appropriate volatility future contract is the underlying. (e.g., the options expiring the second week of April have the second week of April VXST futures as the underlying).   For instructions on how to get VXST futures quotes go this this post.   To compute the correct greeks yourself go to this post.
  5. Because the underlying for VXST options is the futures contract, the options prices do not track the VXST particularly well.  A big spike on the VXST will be underrepresented, and likewise a big drop probably will not be closely tracked.   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 good news is that with the VXST shorter expectation horizon (9 days) at least we have something more responsive that VIX futures / options. The only time the VXST options and VXST are guaranteed to sort-of match is on the morning of expiration—and even then they can be different by a couple of percent.
  6. The VXST options are European exercise. That means you can’t exercise them until the day they expire. There is no effective limit on how much VXST options prices can differ from the VXST index until the exercise day.
  7. Expiring In-the-Money VXST options give a cash payout.  The payout is determined by the difference between the strike price and the SVRO quotation on the expiration day.  For example the payout would be $1.42 if the strike price of your call option was $15 and the SVRO was $16.42.
  8. The expiration or “print” amount when VXST options expire is given under the ^SVRO symbol (Yahoo) or $SVRO (Schwab).   This is the expiration value, not the opening cash VXST on the Wednesday morning of expiration.  VXST options expire at market open on expiration day, so they are not tradeable on that day.
  9. VXST options do not expire on the same days as equity options. It is almost always on a Wednesday before or after the Friday equity option expiration date.   This odd timing is driven by the needs of a straightforward settlement process.  On the expiration Wednesday the only SPX options used in the VXST calculation are the SPX weeklies that expire in exactly 9 days.  For more on this process see Calculating the VIX—the easy part.
  10. The bid-ask spreads on VXSToptions will tend to be wide .   You should be able to do better than the posted bid/ask 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.
  11. I don’t recommend you start trading options on VXST if you aren’t an experienced option trader. If you are a newbie trade something sane like SPY options first…
  12. The VXST is not like a stock, it naturally declines from peaks. This means its IV will always decline over time. VXST options as a result will sometimes have lower IVs for longer term options—not something you see often with equities.
  13. 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 VXST “print”-when the VIX value in calculated from the first SPX options transactions. The first VXST quote of the day is usually at least a minute after opening.


Guest Post: Modified Davis Method—March 2014 Update, by Frank Roellinger

Saturday, March 29th, 2014 | Vance Harwood

It’s been about 7 months since my first article on The Modified Davis Method appeared, so it’s time for an update.  Here is the original chart updated through 3/28/14.  As before, the top (white) line is the method’s results; the yellow line is the Value Line/Russell 2000 series; the green line is the S&P 500 for reference.


The method is still 100% long after the last buy on 11/30/12 when the Russell 2000 closed at 821.92.  Since then the ETF that tracks the Russell 2000 (IWM) is up more than 42% with dividends reinvested.

The following chart illustrates the method’s computed potential exit points since the Buy on 11/30/12.  The upper line is the weekly close of the Russell 2000 index; the lower line depicts the exit points each week.  The method has remained 100% long in the Russell 2000, despite several pullbacks and the usual plethora of predictions that the market is overvalued and cannot go much higher.


Additionally, the original 4% method would have exited and reentered 3 times during this rally, greatly reducing the gain compared to remaining 100% long.  Searching for thresholds other than 4% and employing the dynamically-adjusted trend line have payed off handsomely this time.

The stop was just barely missed on 02/07/14.  Since then, the stop has risen more than 23 points and is still rising.  The method’s use of breadth suggests that the final top has not been reached.  But, sooner or later an exit point will be breached, and soon thereafter, it will be reported here.

Related Posts

  • Modified Davis Method Moves to 50% Cash
  • Guest Post: The Modified Davis Method, by Frank Roellinger

Contango Takes A Breather

Wednesday, March 26th, 2014 | Vance Harwood

VXX hasn’t hit a new low in 6 weeks, and it’s not because the market is crashing.   What has changed is the shape of the VIX futures term structure—the underlying futures that the various volatility Exchange Traded Products (ETP) like VXX, XIV, TVIX, and ZIV are based on (see volatility tickers for the entire list).

For most of 2009 through 2012 the monthly roll cost between the two front month VIX futures used by VXX averaged around 10% when the market was flat or rising (in contango).  In 2013 this average cost dropped to around 5% and is headed even lower in 2014.


The monthly roll costs of the longer term VIX futures used by VXZ and ZIV have been declining also, dropping from  historic 5%+ highs during 2012 to average slightly above 2% in 2013 and 2014.


This change was driven by a flattening of the VIX Futures term structure.   In spite of the front month’s future being about the same value, the later dated futures values have dropped considerably since early 2013.


Why has the curve shifted?

First of all it’s important to remember that VIX futures are ultimately tied to the prices of SPX options of the appropriate month (e.g., August VIX futures are settled to September SPX options).  So the real driver is the much larger SPX options market.   Not surprising the SPX options premiums have shown the same shift in term structure over this timeframe.


I think this big shift in longer dated volatility is due to two factors:

  1. A lot of people have taken short volatility positions in the last year and a half
  2. Traders are less concerned about volatility spikes in general, so they are paying less for longer term “insurance” via SPX options and VIX futures

Both of these factors would tend to depress longer term SPX option prices—and VIX futures prices.   It’s possible that this trend will continue, leading to the flattened term structure we saw in 2007 and early 2008 —at the end of the last bull market. But I doubt it; instead I expect the term structure to stabilize until we see another real VIX spike (into the 40’s).

Coincident with the drop in contango, there has been a leveling off of the open interest in VIX futures.  I don’t think either of these changes caused the other—but perhaps I’m missing a linkage.




Up until 2013 the open interest had been growing 40% per year, but since then the shorter term open interest has stabilized and the medium term open interest has pulled back around 20%.   VIX futures volume on the other hand has continued to set records.  Volatility ETP asset growth was a big driver in VIX futures starting in 2009, but currently the total assets in those funds have hit a plateau.

VXX will probably set some new lows in the next month or two, but expect it to moderate its losing ways for a while.

Ten Questions About Short Selling

Wednesday, March 5th, 2014 | Vance Harwood

We don’t have good metaphors to help us understand the short selling of equities.  It’s easy to understand a straight “long” investment.  For example, planting a garden is a reasonable analogy—it involves buying seeds, planting them, and in due time there is a payoff—or not.

But in real life people rarely borrow something, immediately sell it, and hope to buy it back at a cheaper price.   Since we aren’t familiar with selling short many of its characteristics are counterintuitive.

Below I’ve listed some common questions and answers—hopefully they’ll make short selling a little easier to understand.

How do you measure the returns on a short sale? 

  • On a regular investment we use the initial cash outlay as our basis, and we divide the final result by that basis (and subtract one) to get percentage returns.   However in a short sale there is no initial cash outlay, no investment with which to compute the ROI.
  • The best solution I’ve found is detailed in this paper.   They use an internal rate of return approach. The key formula is:

    Return = (Initial Cash flow + Final Cash flow) / Initial Cash flow

    So for example if I short 100 shares of XYZ corp at $10, I will see $1000 deposited in my margin account.  If I close the position after the stock climbs to $11 my percentage loss is:

    (1000-1100)/1000 = -0.1   A 10% loss.

What is the maximum percentage gain possible on a short sale?

  • Unlike a long position, the maximum profit on a short sale is limited.  The best case is when the stock you shorted becomes worthless.  The final cash flow in that case would be zero.  The return would be:

    (Initial Cash flow + 0) / Initial Cash flow = 1     A 100% gain.
  • Barclays’ XXV fund is essentially a true short (not a rebalanced inverse fund) of VXX that was initiated July 16th, 2010. VXX has decreased a factor 40 since that date (split adjusted 1751 to 43.24), but XXV has increased less than a factor of 2—from 20 to 38.42.  The chart below compares XXV’s performance to XIV, an inverse, daily resetting ETN.


From Yahoo Finance

What’s the leverage of a short sale position?

  • For a standard long position, the leverage is always one; if the stock goes up 10% your position goes up 10% in value.   For a short position the leverage is variable, ranging from near zero to very high.
  • At initiation a short position has a leverage factor of one, but that leverage changes as soon as the price of the security changes—and not in the short seller’s favor.  If the security increases in value above your sale point the leverage increases above one, below it drops under one.
  • For example, assume you sold short at $10, and the security is now at $12.  An additional  +10% move to 13.2 would result in a -12% return—a leverage factor of 1.2

    (1000-1200) / 1000 = -.2 (-20%)     1000-1320 / 1000 = -.32 (-32)
  • Conversely,  if you sold short at $10 and the security is at $8 an additional 10% drop to $7.2 would only net a 8% return for you—a leverage factor of 0.8

    (1000-800)/1000 = .2 (20%)    (1000-720)/ 1000 = .28 (28%)
  • The chart below shows the changes in short position leverage (XXV in this case) as the underlying (VXX) moves

 Can I short securities in my IRA?

  • No.  IRS rules prevent borrowing within an IRA account—this rules out borrowing stock, the first step in a short sale.   Buying inverse exchange traded funds like SDS and XIV is usually allowed, but your broker may require some extra paperwork.  For more on IRAs see “15 Questions About Trading in an IRA”.

What happens if I’m short a security when it goes ex-dividend?

  • You owe the dividend.  Your broker will deduct the dividend amount from your account on the distribution date.  For more on dividends see “10 Questions About Dividends”.

My short sale won’t go through because my broker says shares aren’t available to borrow.  What should I do?

  • Call your broker.  Sometimes shares are available to borrow if you are willing to pay an additional fee—which can be relatively small (e.g., 7% per year).
  • Consider using options instead, being long puts can give you a chance to profit if the security drops—with a fixed limited risk if you’re wrong.  Unfortunately options have expiration dates, a premium price, and sensitivity to volatility levels.  If you have approval to sell naked calls you can create a synthetic short (long puts, short calls at the same strike price) that closely models a short position.
  • Talk to other brokers.  Some specialize in meeting the needs of short sellers.
  • Look to see if there are equivalent inverse exchange traded funds or notes available.  See below for a discussion on inverse funds.

What is a short squeeze?  Should I worry about it?

  • A short squeeze can occur if the security has a relatively restricted supply of shares.   If share owners are holding tight (e.g., enjoying a recent run-up in the stock), then short sellers can get into a desperate situation with each other— bidding up the price of the stock trying to close out their positions and stem their losses.
  • If you are thinking of shorting a stock, you should check the float, a measure of share availability, and the short interest. is an example website that provides that information.
  • Properly functioning exchange trades funds and notes are not susceptible to a classic short squeeze because they can routinely create shares if the security starts trading at a premium to the index it tracks.  For more see “If There’s Liquidity It’s Not A Short Squeeze

What does it mean that the shares I borrow can be recalled at any time?

  • In a standard short selling arrangement, the loaner of the shares you borrowed can recall their shares at any point—for example they might want to sell out their position.  In practice this is rare, and the solution is straightforward—buy shares on the market to close out your position.  Your broker will then return the shares to the lender.  At that point you can re-enter the position if you want to.

What is a margin call?

  • When you sell short your broker will require you to have extra funds set aside in your margin account in case your short sale position starts losing money.  Your broker will require that you always have enough funds in your account to close out your position.  A margin call is a notification that you either need to add cash to your account, or cover some of your short position to reduce your exposure.  If you don’t act, your broker will reduce your short position by buying back some of the security.

What are the trade-offs between short selling and buying a resetting inverse exchange traded fund/note (ETF/ETN) on the same security?

  • The advantages of a short position are:
    • No path dependency—the value of an inverse fund is dependent on how it gets to a certain value.  For example big up and down moves, even if they cancel out will erode the value of an inverse fund.  This can be a big deal.
    • The advantages of an inverse ETF/ETN are:
      • Constant leverage, the daily percentage moves will closely track the opposite percentage moves of the underlying security.  Most inverse funds will rebalance daily to keep their leverage consistent.
      • Potential gains greater than 100%.  The resetting process of these funds enables them to avoid the 100% gain limitation of a short sale.  For example, VelocityShares’ XIV inverse fund is up 225% since its inception 30-Nov-2010.
      • Avoids the issues of  trying to borrow shares, recall of shares, and margin calls (unless the shares were bought on margin)

VXST Index, Futures Quotes and Expiration Dates

Friday, February 21st, 2014 | Vance Harwood

VXST Indexes

On  October 1st, 2013 the CBOE introduced the VXST index. VXST uses the same methodology as the CBOE’s VIX® index except that it gives the market’s 9 day expectation of volatility rather than the 30 day.  VXST options on VXST futures started trading April 10, 2014.

Some of the tickers related to the VXST are:

Quote Provider


Futures Symbols

Settlement (SOQ)


Far Week



1VSW/<> 2VSW/<>

<> = mo code + yr (see below)




Yahoo Finance





Google Finance









The CBOE publishes two intermediate calculations (VSTN & VSTF) that are used to the compute the VXST index.  These two indexes do a VIX style calculation with just the nearest SPX weekly options (VSTN) and the next available set of SPX weekly options (VSTF).   The VXST is a variance (not linear) interpolation between these two indexes that gives a 9 day expectation of volatility.

At expiration the VXST calculation uses the same option series utilized in the VSTF—the SPX weekly options that will expire in 9 days.  These indexes are analogous  to the VIN and VIF used in the VIX calculation.  For more on this see Calculating the VIX index—the “easy” part.


VXST Futures

On February 13th, 2014 the CBOE started trading futures on their new VXST based index.

Currently the CBOE has opened up futures trading up to  5 sequential weeks of VXST.  The futures typically expire on Wednesday morning.

The full ticker symbology for VXST futures is given here.  For CBOE delayed quotes the symbol is constructed with one of the 5  preambles:  1VSW, 2VSW, 3VSW, 4VSW  5VSW followed by a “/” and then the futures month and year code (see below for details).  So for example the VXST futures expiring 26-Feb-2014 will have the symbol:  4VSW/G4.  The futures are numbered by the week of the month that they expire, so the futures expiring the first week of the month will have the 1VSW preamble, 2nd week  2VSW, and so on.

The settlement price at expiration for VXST futures and options  will be computed using the CBOE’s Special Opening Quotation (SOQ) process and will be distributed under the SVRO symbol.  This price is not the same as the VXST opening quote on the day of expiration, the SVRO print will occur at least a few minutes after market open.   The SVRO price is derived from actual option trade prices, not the split bid/ask price that the index calculation uses.
VXST Options

VXST options started trading April 10, 2014.    The most important thing to remember with VXST (and VIX) options is that the underlying is not the index, but rather the future that expires on the same day as the options.   As with VIX options the last day of trading is the day before settlement, which is typically a Wednesday.   For more on trading VXST options see 13 Things You Should Know About VXST options.


The futures month codes are:



























The year code is just the last digit of the year (e.g., 4 for 2014).