All about VIX options - derivatives of a derived index based on derivatives
While the VIX is a novel market derived from options that are themselves derivatives of derivatives, the proposition becomes even more interesting when options on this asset are introduced. VIX options will of course resemble the construction of all options and so maintain a volatility variable in their own pricing. Due to the filtered effects of a sporadic third derivative equity market such as the S&P, with the proverbial mayhem that may admittedly, seldom occur, the VIX exhibits high volatility itself of up to 80%. This type of market is littered with trading opportunity.
Indeed, rarely do other option markets exhibit such high implied volatility, and options on the VIX are an even better suggestion therefore, than the underlying VIX. When the VIX is at the bottom of its range, VIX calls offer a perfect hedge for any equity portfolio that will be protected against a significant collapse in the stock market. When the VIX is high, unprecedented returns can be achieved by selling VIX calls. Here not only will there be a capital gain in the share investment, but the fact that equity markets rise at a slower rate will mean that volatility will fall and so profits are realized on the VIX calls also. In a world of competitive fund management, strategies such as this are invaluable.
Of course, high volatility in the VIX will bring with it large premium. Large premium will bring with it large time decay and also large vega. It is these characteristics of the VIX options market that will ensure that risk profiles within the VIX option market shift quickly, and so thorough monitoring of a position and its associated derivative markets is needed in order to retain control over the investment.
By its very nature, the VIX options market will in the fullness of time become imbued with a definite skew. When volatility is high, pressure will be upon calls rather than puts, and so great theoretical value will be had in executing a collar. Similarly, when volatility is low there will be great upward pressure on puts. Many equity option markets reflect similar skews due to the character of markets falling more quickly than they rise however, the skew apparent in the VIX option market will have a dynamic quality about it; it will be accentuated when the VIX itself is on its lows (approximately 10%) and then disappear when in mid-range. Then as the VIX approaches 50% the skew will re-emerge. The initiation of the skew by either calls or puts, depending on where the underlying VIX is placed, will lead implied volatility to be revised up or down as the case may be.
Indeed, rarely do other option markets exhibit such high implied volatility, and options on the VIX are an even better suggestion therefore, than the underlying VIX. When the VIX is at the bottom of its range, VIX calls offer a perfect hedge for any equity portfolio that will be protected against a significant collapse in the stock market. When the VIX is high, unprecedented returns can be achieved by selling VIX calls. Here not only will there be a capital gain in the share investment, but the fact that equity markets rise at a slower rate will mean that volatility will fall and so profits are realized on the VIX calls also. In a world of competitive fund management, strategies such as this are invaluable.
Of course, high volatility in the VIX will bring with it large premium. Large premium will bring with it large time decay and also large vega. It is these characteristics of the VIX options market that will ensure that risk profiles within the VIX option market shift quickly, and so thorough monitoring of a position and its associated derivative markets is needed in order to retain control over the investment.
By its very nature, the VIX options market will in the fullness of time become imbued with a definite skew. When volatility is high, pressure will be upon calls rather than puts, and so great theoretical value will be had in executing a collar. Similarly, when volatility is low there will be great upward pressure on puts. Many equity option markets reflect similar skews due to the character of markets falling more quickly than they rise however, the skew apparent in the VIX option market will have a dynamic quality about it; it will be accentuated when the VIX itself is on its lows (approximately 10%) and then disappear when in mid-range. Then as the VIX approaches 50% the skew will re-emerge. The initiation of the skew by either calls or puts, depending on where the underlying VIX is placed, will lead implied volatility to be revised up or down as the case may be.
Comments