Trading the VIX - Macroption

When investors buy and sell options, the positions they take—either puts or calls—the prices they are willing to pay, and the strike prices they choose, all reflect how much and how quickly they think the underlying index level will move. VIX uses options prices rather than stock prices in its calculation because options prices reflect the volatility buyers and sellers expect. The VIX time frame is significant. That is enough time for investors to make decisions and act on them, but close enough to add a note of urgency if significant change is forecast.

Many investors use an investment linked to the VIX to diversify their portfolios, seeking to hedge portfolio risk without significantly reducing potential return. For example, when markets are unsettled, investors may allocate a small percentage of their capital to VIX-related products, such as ETFs or ETNs linked to VIX futures, hoping to offset anticipated losses in their investment portfolios.

Second, VIX tends to rise more dramatically when markets fall significantly. This characteristic of typically reacting more dramatically to a large equity loss than to a large equity gain is called convexity. Convexity means the investments associated with VIX may provide greater protection when it is needed most. Volatility can be bought or sold. It works as a diversification tool.

It can provide a positive return, although it pays no interest or dividends. But unlike most traditional asset classes, volatility is never a long-term investment. The recurring up and down pattern of the market cycle may encourage investors to sell VIX-linked products following a weak period in equity markets.

Why Trade VIX

In this case, they anticipate equities will begin to gain value and the prices of volatility-linked products will decline. Alternatively, when VIX is low, investors may wish to buy VIX-linked products in anticipation of a future period of weakness. These similar trading strategies aim to exploit the historical tendency of VIX to revert to its mean after a period of increasingly higher or lower levels.

Investors may also seek arbitrage opportunities that result from mispricing of VIX-linked products. For example, they may sell individual options and take an opposite position in VIX-linked products, particularly if the implied volatilities of the individual options look expensive compared to VIX. Or, they may take opposite positions in VIX options or futures with different maturities. In some cases, for example, premiums on VIX-linked options may be higher or lower than realized volatility justifies, and exploiting this discrepancy may produce a profit.

Like other indices, VIX is expressed as a level, or number. Changes in the level, up or down, are expressed as percentages. For example, if the current level were 10—which is at the low end of historical readings—the deannualized day implied volatility is 2. Both standard and weekly option contracts with expirations in the 23 to 37 day range are eligible. Once a week, the options used to calculate VIX roll to new contract maturities.

On the following day, the options that expire in 30 calendar days would become the near-term options in the calculation and SPX options that expire in 37 calendar days would become the new next-term options. As each VIX calculation begins, the first step is determining which option contracts, with strike prices higher and lower than the current SPX level, will be included.

• Volatility Fishing Expedition!
• Three VIX Trading Strategies for .
• Top Stories.
• belajar forex cepat;

The number of contracts may vary from calculation to calculation, but typically includes more than puts and calls. To make the cut, the contracts must have current non-zero bid and ask prices, or what is known as a quote, from investors willing to buy or sell at that price.

The further a strike price is from the current SPX level, the less likelihood there is of finding a quote, and contracts without quotes are excluded. At the point that two contracts with consecutive strike prices do not have quotes, no additional contracts are eligible for inclusion and the components are set. In the next step, the options contracts that have been selected are weighted to ensure that each has the required impact on the calculation. The VIX formula is designed to combine options in a way that means that subsequent movements in the VIX are dependent only on the volatility of the underlying.

The precise justification for the weighting is technical, but it results in a system that weights each option in inverse proportion to the square of the option strike price. Accordingly, VIX is more sensitive to changes in the prices of options with lower strikes and less sensitive to options with higher strikes. So investors use products linked to VIX to hedge their portfolios against market risk or to trade volatility. Each of these products works differently, attracts investors for different reasons, and poses different potential risks.

What links them, however, is that as equity markets fall, VIX rises, prompting a corresponding though not identical change in the value of products linked to VIX. Any increase in the value of the ETFs and ETNs they own can be used to offset portfolio losses or to realize a profit. The greater potential risk, however, is the result of the characteristic market expectation that VIX in the future will be higher than current VIX—an outlook that is even more pronounced when the VIX level is low.

When a market is in contango, the price of a futures contract with a later expiration date is higher than the spot price of the current contract. That possibility makes these VIX-linked products typically appropriate only as very short-term investments, often as short as a single day. The problem is that this approach runs counter to the buy-and-hold strategy that investors often adopt with ETFs and ETNs linked to traditional indices. Recently, some issuers have launched VIX-linked products— typically tied to more sophisticated investment strategies—that are potentially more appropriate to be used as buy-and-hold investments.

If a stock investor chooses to buy a protective put, they are more in favour of choosing one at lower strike prices. Even though, an OTM put is cheaper than its ITM counterpart, it also offers less protection against downward movement. If, however, the investor is so concerned about a downward movement that they require the protection of an ITM protective put, he should simply sell the stock instead Natenberg, If the stock investor chooses to sell a covered call, they will almost always favour choosing one at higher strike prices.

This offers less protection compared to the sale of an ITM call, but the investor most likely holds the stock because he assumes an increase in the share price.

Introduction

The investor will want to participate in at least some of the upside profit potential, if the stock price increases as presumed. The stock will be rapidly called away, limiting any upside profit, if the investor has sold an ITM call and the share price increases. In the equity option market, pressure tends to exist on both sides: buying pressure on the lower strike prices the purchase of protective puts and selling pressure on the higher strike prices the sale of covered calls.

This causes: IVs to increase with lower strike prices and IVs to decrease with higher strike prices. The resulting skew shape is referred to as reverse skew pattern and is common for options in the equity market.

Why Investors Use Vix

The volatility skew transforms into an essential aid in managing risk and generating valuable theoretical values by handling it as an additional input into the theoretical pricing model. Furthermore, the skew analysis can build the foundation for a range of different option strategies Natenberg, Trading volatility as an asset class in its own right has a number of good reasons.

For instance, investors may gain diversification by adding volatility to an equity portfolio as equity volatility is strongly negatively correlated with the equity price. Furthermore, investors may attain insurance against market crashes by holding volatility in an equity portfolio. This, in turn, is because volatility tends to rise significantly at such moments. They are mentioned here to give an impression of some features associated with volatility or volatility-based instruments.

Whereas speculative traders may simply bet on future volatility, arbitrage traders and hedge funds may take positions on dissimilar volatilities of the same maturities. For trading pure volatility, instruments directly based on volatility indices have been established as popular instruments Alexander, Indirect instruments, however, reflect the trade on volatility via volatility indices. It should be noted that the application of indirect instruments is presented and analysed in this paper.

These indirect instruments base on volatility indices. Shortly after its introduction, the VIX index transformed into the premier benchmark for U. Their intention behind this update was not only to reflect a new way of measuring expected volatility implied volatility , but above all to create a measure that can be used by financial theorists, risk managers and volatility traders in a similar manner.

This new methodology transformed the VIX index from a previously abstract concept into a practical standard for trading and hedging volatility by supplying a script for replicating volatility exposure with a portfolio of SPX index options. Since their introduction weekly options have transformed into a very popular and actively traded risk management tool that are available on many indexes, equities, ETFs and ETNs. Through August , SPX Weeklys averaged over a quarter of a million contracts traded per day and constituted about one-third of all SPX option contracts traded.

Volatility

This represents the most successful new product in CBOE history. Combined trading activity in VIX futures and options has risen to a daily trading volume of over , contracts within merely 10 years since their launch Chicago Board Options Exchange, The inverse relationship between equity volatility and equity market returns is well documented and suggests a diversification benefit of incorporating volatility in an investment portfolio.

VIX futures and options are both instruments that offer investors the possibility to obtain a pure volatility exposure in a single and efficient package. VIX products are available to all types of investors, from the smallest retail trader to the largest institutional money managers and hedge funds. This section examines how volatility actually behaves in practice. This represents essential knowledge when considering trading with VIX futures and options or volatility derivatives in general. Therefore, stylized facts about volatility must be examined Sinclair, A stylized fact can be defined in the study of financial data represents a property that is strong enough to be accepted as universally valid.

Econometric studies have revealed considerable amounts of commonalities in financial time series of different assets. It was found that the fluctuations in asset prices share several significant statistical properties. These properties have become known as stylized facts. It should be emphasized that the stylized facts described here basically represent generalities, which means they do not need to prove true in every individual case. Despite the loss of precision when using generalities, they are useful for spotting broad similarities.

Many of the facts will be qualitative. It is extraordinarily complex to integrate all these properties into models of the underlying, let alone option pricing models. Therefore, the objective should not be to search for a pricing model that captures all these properties, but to use tweaks and fudges to integrate these facts into the use of the Black-Scholes-Merton formalism and the volatility estimation problem. Thus, for volatility traders, it is essential to know as much as possible about any fact that concerns volatility. Stylized facts show up following characteristics:. This effect is asymmetric: negative returns cause volatility to rise sharply while positive returns lead to a smaller drop in volatility.

This effect occurs most prominently in equity markets. The effect is uncomplicated to visually confirm and robust to the exact way volatility is estimated. Therefore, it shows the historical fluctuation intensity of the SPX. Two interesting properties can be observed. The phenomenon of volatility clusters appears to have been first noticed by Mandelbrot Significant autocorrelations are shown in particular by both squared returns and absolute returns proxies for one-day volatility.

Figure 4 and Figure 5 illustrate these autocorrelations for the SPX as a function of a range of lags. Figure 3. Figure 4. Autocorrelations for the daily squared log returns of the SPX from to Volatility clustering occurs independent of the underlying instrument.

It has been observed across a variety of different assets, including indices, equities, commodities, and currencies Taylor, Clustering suggests that the current volatility level represents a good estimate for future volatility. They do not value how remarkable this piece of information is for their trading activities. Volatility clustering implies that volatility is relatively predictable.

This represents a significant feature which the underlying price certainly does not have. Another important stylized fact to be mentioned is the inverse relationship between equity prices and volatility. This persistent effect indicates that volatility. Figure 5. Autocorrelations for the daily log returns of the SPX from to This, in turn, increases its risk and leads to higher volatility.