On May 28th, options on the iPath S&P 500 VIX Short-Term Futures ETN (VXX) ETN started trading. Given the popularity of VXX I suspect these options will be popular. For one, it should give a reliable way to effectively short the VXX —at least on Schwab’s trading platform it has been difficult to short VXX itself. Most of the time (even during this recent volatility run-up), it has been in the “hard to borrow” category.
It is interesting to conjecture how the VXX options will behave compared to their cousins, the VIX index options.
Similarities:
- Both based on S&P 500 volatility futures
- Will show a strong reversion to baseline behavior when the market is behaving itself—the VIX index and VXX will tend to quickly drop to a lower “stable” value
- Will not track the peaks of the VIX index. The volatility futures are tied to future values of volatility (duh) , rather than today’s value—so they tend to move significantly less, although pretty much in time synchronization. The values jump at the same time, just not as much.
- The spread between bid and ask will be wide for at least in-the-money calls
Differences
- VXX options expire on Saturdays—the same day as most equity/ETF options, not on the Wednesday that futures expire for that particular month.
- The VXX settlement value will probably be the closing value of VXX on the Friday before the options expire, not the once per month VRO settlement value used by the VIX options—which is rarely if ever the same as the Wednesday opening print of the VIX index.
- The VXX, and hence VXX options will be sensitive to the relationship between the current and next month futures prices on volatility. The VXX shifts its weighting between these two months on a daily basis. Generally this results in a price erosion force on the VXX relative to the VIX index because the further out month is usually higher in value than the close in month (called “contango” in futures parlance)
- The implied volatility of the VXX options should generally be lower than the equivalent VIX options, because it is the mix of two months of volatility futures, not one like the VIX options. For example, for June expiration the volatility should be about the same the day after the May VIX options expire (because both sets of options are tied to June futures) , and the VXX option volatility should decrease relative to the VIX options as the time remaining on the June options decreases and the VXX picks up more weighting in the July volatility futures.
- The VXX options quotes/option chains will be easier to find and their greeks will be correct. VIX index quotes are not even available on Google finance. Yahoo finance gives VIX index quotes (^VIX), but not option quotes or chains. And everyone, including Schwab and Fidelity report incorrect greeks for VIX options– LIVEVOL being the only exception I am aware of.
- The VXX options have American style exercise rather than the VIX option’s European style exercise. The European style exercise was necessary on the VIX options because the VIX options and VIX index are only guaranteed to line up once—at expiration time. The VXX and its options will naturally track each other well, so American exercise is ok. Practically this won’t be a big deal.
In the “no free lunch” category, I predict attempts to use VXX/ VIX options to take advantage of VXX’s historical price erosion compared to the VIX because of futures contango without taking volatility risk will not be profitable. This might manifest itself as large bid/ask spreads for some strike prices.
Summary
I think the VXX options will be popular with the retail crowd. They behave like regular stock options with the same expiration dates, settlement practices, American style exercise, and available/accurate quotes, option chains, and greeks. I think the pros will contue to use the VIX options because they provide a purer play on S&P 500 volatility.
For more information see:
VIX and More
Daily Options Report by Adam Warner — if your head isn’t spinning yet…
CBOE news release
