Volatility White Papers: Power Laws & VIX Options Explained

Updated: Mar 25th, 2017 | Vance Harwood

Recommended Papers

  •  Tales of the Unexpected by Andrew Haldane
    • This accessible paper (only one equation) is the best that I’ve ever read on the differences between processes accurately modeled by Gaussian/normal distributions and those better matched by power law distributions.   I have seen this distinction made many times, but this paper provided examples and reasoning that really helped me internalize the differences.   Most of our stock market computations (including Black & Scholes for option pricing) and risk management formulas assume normal (or log-normal) distributions, but this paper lays out a compelling case for why power law distributions are often a better match.


  • Understanding VIX Futures and Options by Dennis Dzekounoff
    • This article contains an excellent overview of the peculiarities of VIX options including their Greeks and term structure.    Most broker’s Greeks for VIX options are completely wrong to start with, but Dennis points out some other issues like steep call skew, dangerous calendars, and slower than expected theta decay.

VXX Options—Similarities and Differences with VIX Options

Updated: Mar 10th, 2017 | Vance Harwood

VXX options give a reliable way to effectively short the VXX—at least on Schwab’s trading platform it’s difficult to short VXX itself.  Most of the time  it has been in the “hard to borrow” category.

Comparing VXX options to VIX options:


  • Both are 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.


  • VXX options expire  on Friday for Weeklys or Saturdays—the same day as most equity/ETF options, not on the Wednesday that futures expire for that particular month.
  • The VXX settlement value is 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
  • 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.   Many brokers including Schwab report incorrect greeks for VIX options—the CBOE’s  LIVEVOL  being the only exception I am aware of.  Fidelity gets partial credit—their delta and gamma are correct for the next to expire monthly options,
  • The VXX options have American style exercise rather than the VIX option’s European style exercise.  The European style exercise is necessary on the VIX options because the VIX options and VIX index are only guaranteed to be near each other 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.


VXX options are 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 continue to use the VIX options because they provide a purer play on S&P 500 volatility.

Doubling up on Oil, betting on VIX dropping

Updated: Mar 12th, 2012 | Vance Harwood

Did covered calls on Oil — bought USO at 37.19, sold-to-open May 37 calls at 1.02 for a net investment of 36.18.

Created a bear spread on VIX options today.   Betting on VIX going down is forecasting that the market in general will be flat or positive.  I sold-to-open June VIX 16 calls at 10.26, bought  June  VIX 32.5 calls at 1.88 for a net credit of  8.38.  I was able to approximately split the bid/ask prices with my combo order.   At the time of the order the spreads were approximately 10.00 / 10.60 on the June 16 options and 1.80/1.95 on the June 32.5 calls.  Going with the published bid/ask prices leaves money on the table.

The VIX cash index was around 28.5 at the time my order filled.   I initially tried to go short on VXX, but Schwab had VXX in the “hard to borrow” category this morning.   I suspect lots of people were trying to short the VXX today.   I went with June options rather than May because there are only 7 days left on the May VIX options–I wouldn’t be surprised at all to see one more down leg in this correction.    I expect the June options will move much down much slower than the VIX index as the market moves away from fear mode.

Going short on VIX?

Updated: Mar 11th, 2017 | Vance Harwood
Unlike the S&P 500 or Dow Jones Index there is no way to directly invest in the VIX index.  I’m sure some really smart people have tried to figure out how to go long or short on this computed volatility index, but currently there’s just no way to do it directly.  Instead, you have to invest in a security that attempts to track VIX.  None of them do a great job of this.   I’ve given a short answer and a long answer below on how to best short the VIX given the current choices.  Take your pick.
Short Answer
  • Buy VelocityShares’ ZIV inverse medium-term volatility.   This product follows general volatility trends, but doesn’t have the neck snapping moves of the short-term based products.   You definitely still want to exit if the market volatility starts climbing, but you have more time to react.   In the post Timing Inverse Volatlility with a Simple Ratio I provide a straightforward method to time your ZIV entries / exits.
  • If you want to aggressively short on VIX buy VelocityShares XIV or ProShares SVXY
    • XIV & SVXY attempt to match the opposite percentage moves of VXX.  Since VXX only manages about 50% of the VIX’s percentage moves you should expect XIV to have a similar behavior.  For more on XIV see this post.

Long Answer

The  current set of securities that attempt to track volatility include:

  • Volatility futures contracts  (CBOE VIX Futures)
  • Options on volatility contracts (CBOE’s VIX options)
  • VXX & VXZ ETNs with theirVelocityShares, ProShares, and UBS investment bank competitors (rolling blends of futures contracts that trade like stocks). See this post for a complete list.  See  How to short VXX for specifics on shorting VXX.
  • Options on VXX, VXZ, UVXY, SVXY
  • Inverse funds that attempt go up when volatility goes down
    • VelocityShares’ XIV ETN  (goal—daily short term inverse returns).  Looks like a good vehicle for this.  More info here.
    • ProShares’ SVXY ETF  (goal—daily short term inverse returns).  This is the only Exchange Traded Fund (as opposed to a Exchange Traded Note) in this area.
    • VelocityShares’ ZIV ETN  (goal—daily medium term inverse returns).   More info here.
    • Barclays’ IVOP ETN  (short of VXX that started trading 16-Sept-2011).   More info here.  Not Recommend—low leverage.
    • Barclays’ XXV ETN (short of VXX that started trading 19-July-2010).  Not recommended—very low leverage.  More info here.
  • CVOL (leveraged blend of futures contracts plus short S&P500 position). More info here.  (not recommended because no new shares are being created)

All of these choices can be at least theoretically used to bet that the VIX index will go down.  Futures contracts or VXX can be shorted, VIX or VXX puts can be bought, or calls shorted, and XIV can be bought directly.

All of these choices have significant problems.

  • None of them track the VIX index particularly well, they tend to lag the index considerably
  • VXX can be hard to short (Schwab has had it in their “Hard to Borrow” category for a long time) and you can’t short stocks / ETFs/ETNs in an IRA account.  Fortunately XIV, SVXY, and ZIV are available,
  • Long VIX / VXX put options have serious time decay issues—if the VIX doesn’t drop when you expect your positions bleed money.
  • Because volatility products are relatively volatile the premiums on options tend to be expensive.
  • Unhedged short positions leave you exposed to losses larger than your initial investment if you forecast incorrectly.  Your losses if the index spikes won’t be unlimited because nothing goes up infinitely, but it could be enough to really hurt.  Even the lethargic VXX managed rallies of around 2X in 2010 and 2011.

On the positive side of betting that the VIX index will go down, the VIX index and all of its proxies show mean reversion.  After it spikes up, fear always subsides, and any surviving short position would reduce its losses over time and potentially turn profitable—assuming you didn’t get in when the VIX index was really low.

Better yet, short positions on VXX or similar products will also profit from the contango associated with the volatility futures these products are based on.

If you decide you want to go short on the VIX index, I think it makes sense to limit your potential losses if volatility spikes, either with stop loss orders, or with VIX or VXX OTM calls that would really kick in to limit your losses.  Stop loss orders are scary because if the market is gapping you might lose quite a bit more than your stop loss order would suggest.   For example if you are short VXX at 40 and your stop loss is set at 42, your order might fill at 44 if the market gaps down significantly at opening.   The type of stop loss order that becomes a limit order rather than a market order when triggered prevents this scenario, but opens you up to an even worse loss if volatility continues to spike and never trades at your limit price.

Even though it is scary, I think a stop loss order would probably work well. At least looking back over the last couple of years, including the flash crash, the market was orderly enough to prevent large losses if reasonable stop loss orders had been in place.

VIX Option and Futures Expiration Dates

Updated: Mar 10th, 2017 | Vance Harwood

Upcoming expiration dates for monthly VIX options and futures—they expire at market open on the same days can be found here.  The settlement price is not the same as the VIX open price. The settlement price is listed under the VRO ticker and reflects the result of a process (HOSS) managed by the CBOE.  If settlement process involves actual trade prices, not the mid-price quotes used in the VIX calculation process so the ultimate settlement price can be significantly different from the VIX open price.

The last day of trading for expiring VIX options is the end of regular trading on the day before (typically Tuesday).  Expiring VIX futures on the other hand trade in extended hours trading until 7:00 AM ET on the day of expiration (typically Wednesday).

See this post for thirteen things you should know about trading VIX options.

The underlying security for VIX options is not the CBOE’s VIX index, rather it is the volatility futures expiring on the same date.   The CBOE’s Future exchange site has delayed quotes on VIX futures.  The symbology is not obvious, for example, the ticker for Dec 2014 futures would vix/z4.  The symbol is built up by taking “vix/” plus the month code  (month codes are listed here). plus the last digit of the year (4 for 2014).

The VIX and volatility futures do approximate each other on their expiration date (see below for the discussion on VRO), but otherwise the volatility futures can be lower or higher than the VIX.  VIX central is a very useful website that not only gives the VIX futures delayed quotes, but also shows the term structure—a graph of the VIX Futures for the various expiraton dates vs time.  The VIX central site also has historical VIX Futures data which can be compared to the term structure of the CBOE”s constant maturity indexes: VXST, VIX, VXV, and VXMT which show 9, 30, 93, and 180 day expectations of volatility.

You can also get a good estimate for the volatility futures prices by looking at the $10 VIX call for the the corresponding option series.  For a given set of options if you split the bid/ask price of this deep in the money option, and add 10 you are pretty close to what the VIX futures for that expiration are trading at.   For example, if the $10 call is at 8.50 bid, 8.90 ask, then split the difference to get 8.70, and add 10 to get 18.70.  This is the approximate VIX futures price that underly those options.   Volatility ETN products (e.g, VXX, VXZ, XIV, ZIV, UVXY, SVXY, TVIX) are based on various uses / mixtures of the monthly futures.  See Volatility Tickers for a full list.

The exercise / settlement values on the expiration date are not the opening values of the VIX / RVX index, but rather their special opening quote values.    These quotes have their own symbol and are printed sometime after opening—usually a few minutes after, but it can take an hour or two to achieve a settlement.  The VIX settlement value ticker is VRO  (Yahoo ^VRO, Schwab $VRO), and RSL for the Russell Volatility index.

Source:   OCC and CBOE option expiration calendars

For a spreadsheet calculator for all historical expiration days see this CBOE tool.