VXX Options—Similarities and Differences with VIX Options

VXX options offer ways to take either long or short volatility positions.  Unlike most securities VXX tends to go up when the market is down—which leads to some signficantly different options characteristics.

Comparing VXX options to VIX options:

Similarities:

• Both are ultimately based on the Cboe’s VIX 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 VIX futures that the VXX is based on tend to move significantly less than the VIX percentage wise, although pretty much in time synchronization.
• Because the VIX and VXX will tend to jump up dramatically in troubled times their call option implied volatility (IV) increase with higher strikes.  Normally equity call options will have their IV’s drop with higher strikes on calls and increase on lower strikes for puts.

Differences

• VXX options expire on Friday for Weeklys—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 the options expire, not the Wednesday morning 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.  If the further out month is priced higher than the front month, a situation called “contango” in future’s parlance, there is usually a price erosion trend on the VXX  relative to the VIX index.  For more on this erosion factor see “The Cost of Contango“
• 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 Fidelity report incorrect greeks for VIX options—the Schwab and CBOE’s  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 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. Since VXX doesn’t distribute dividends there is no real reason for a option holder to do an early exercise of their options.

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.

Summary

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.  .