Update: On June 18, 2015 the CBOE announced that they would be discontinuing VXST futures and options. These products have not achieved significant volumes so this wasn’t a surprising outcome. As an alternative solution to the desire for options better tracking the VIX the CBOE has added weekly expirations of futures and options to the already hugely popular 30 day VIX futures. This approach has been very successful. For more information on these options see Thirteen Things You Should Know About Trading VIX Options.
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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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…
- 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.
- 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.