I've noticed people on this and other boards getting excited about the low VIX and talking about trading VIX futures or options (and ETFs or ETNs whose results are derived from futures performance). I want to caution you guys to make sure you understand how these instruments work before you trade them. They DO NOT work the same way as other futures and options, and you can lose money on them even when you are right about the direction of the VIX.
In most cases, futures prices are directly tied to the spot price of the underlying. This is because the underlying has an actual value; if futures prices were to diverge from the spot price, then there would be an opportunity for risk-free profit by arbitraging the underlying bought or sold on the spot market against an offsetting futures position.
Because the VIX is just a number - it has no underlying value - its futures do not work this way AT ALL. Instead, futures prices are simply set by supply and demand for each contract month. The CBOE back-calculates VIX forward prices for each contract month from the corresponding futures price.
Let me give you an example of how this can work out badly. Let's say the VIX is at 20 today. You expect it to be at 40 in March, so you buy March VIX futures. You are not aware of the details of how VIX futures work, so you ignore the fact that the forward VIX value for March is already 50. Now you wait until March, and you were right - the VIX is at 40 in March. You bought futures when the VIX was at 20, so you made 20 points, right? No, you lost 10 points, because the forward value was already 50.
VIX options are priced off the corresponding forward value as well, so they produce similarly skewed results.
Please don't trade VIX derivatives unless you understand this fully and you know the forward value associated with the contract month you are trading.
Thanks Spudthorpe. Excellent points. I agree VIX related securities are some of the least understood on the market. Not only are they complex in structure, but they are extremely volatile, highly time sensitive due to decay, and frankly some of the most difficult to trade.
A trader MUST take the time to understand the securities completely and carefully consider the risks involved. These securities are not appropriate for many individuals.
I agree, SC. I do understand them and I still don't trade them!
I forgot to mention perhaps the worst feature of VIX futures. We are used to seeing futures prices converge to spot prices as contract expiry approaches. Because divergences in VIX futures prices don't create an arbitrage opportunity, VIX futures don't even have to converge to the spot VIX value! So, for instance, you could see VIX at 40 and VIX futures at 38 on the day of contract expiry. That is pretty frustrating!
By the way, I misspoke above - I meant to say forward VIX values are back-calculated from market prices for forward-month index options - but it doesn't change the point.
I believe that the last week of April 2011 commenced an Elliot Wave 2 Up in the $SPX at 1363, and the chart for the last week of October 2011 of $SPX at 1292 is an Elliott Wave 2 of 2 up, and the chart for the second week of January of the $SPX again at 1292 is an Elliott Wave 2 of 2 double top up, with the result that the $SPX, traded by SPY, is going to enter an Elliott Wave 3 of 3 of 3 down for the week ending January 20, 2011 when options expire. These are the most destructive of all economic waves as they for all practical purposes destroy all economic wealth built on the five waves up. This coming down wave is going to take out even the yet to be established ten toed kingdom of regional global government, at which time the Sovereign will take the upper hand and establish a world one world government, with a one world currency and provide global seigniorage.
Perhaps one might enjoy my linked article entitled The S&P Downgrade Of Nine European Nations Terminates The Age Of Liberal Finance And Commences The Age Of Sovereign Default ….. And Terminates Democracy And Commences Regional Global Governance
I believe that the last week of April 2011 commenced an Elliot Wave 2 Up in the $SPX at 1363, and the chart for the last week of October 2011 of $SPX at 1292 is an Elliott Wave 2 of 2 up, and the chart for the second week of January of the $SPX again at 1292 is an Elliott Wave 2 of 2 double top up, with the result that the $SPX, traded by SPY, is going to enter an Elliott Wave 3 of 3 of 3 down for the week ending January 20, 2011 when options expire. These are the most destructive of all economic waves as they for all practical purposes destroy all economic wealth built on the five waves up. This coming down wave is going to take out even the yet to be established ten toed kingdom of regional global government, at which time the Sovereign will take the upper hand and establish a world one world government, with a one world currency and provide global seigniorage.
Perhaps one might enjoy my linked article entitled The S&P Downgrade Of Nine European Nations Terminates The Age Of Liberal Finance And Commences The Age Of Sovereign Default ….. And Terminates Democracy And Commences Regional Global Governance
I've noticed people on this and other boards getting excited about the low VIX and talking about trading VIX futures or options (and ETFs or ETNs whose results are derived from futures performance). I want to caution you guys to make sure you understand how these instruments work before you trade them. They DO NOT work the same way as other futures and options, and you can lose money on them even when you are right about the direction of the VIX.
ReplyDeleteIn most cases, futures prices are directly tied to the spot price of the underlying. This is because the underlying has an actual value; if futures prices were to diverge from the spot price, then there would be an opportunity for risk-free profit by arbitraging the underlying bought or sold on the spot market against an offsetting futures position.
Because the VIX is just a number - it has no underlying value - its futures do not work this way AT ALL. Instead, futures prices are simply set by supply and demand for each contract month. The CBOE back-calculates VIX forward prices for each contract month from the corresponding futures price.
Let me give you an example of how this can work out badly. Let's say the VIX is at 20 today. You expect it to be at 40 in March, so you buy March VIX futures. You are not aware of the details of how VIX futures work, so you ignore the fact that the forward VIX value for March is already 50. Now you wait until March, and you were right - the VIX is at 40 in March. You bought futures when the VIX was at 20, so you made 20 points, right? No, you lost 10 points, because the forward value was already 50.
VIX options are priced off the corresponding forward value as well, so they produce similarly skewed results.
Please don't trade VIX derivatives unless you understand this fully and you know the forward value associated with the contract month you are trading.
Thanks Spudthorpe. Excellent points. I agree VIX related securities are some of the least understood on the market. Not only are they complex in structure, but they are extremely volatile, highly time sensitive due to decay, and frankly some of the most difficult to trade.
ReplyDeleteA trader MUST take the time to understand the securities completely and carefully consider the risks involved. These securities are not appropriate for many individuals.
I agree, SC. I do understand them and I still don't trade them!
ReplyDeleteI forgot to mention perhaps the worst feature of VIX futures. We are used to seeing futures prices converge to spot prices as contract expiry approaches. Because divergences in VIX futures prices don't create an arbitrage opportunity, VIX futures don't even have to converge to the spot VIX value! So, for instance, you could see VIX at 40 and VIX futures at 38 on the day of contract expiry. That is pretty frustrating!
By the way, I misspoke above - I meant to say forward VIX values are back-calculated from market prices for forward-month index options - but it doesn't change the point.
I believe that the last week of April 2011 commenced an Elliot Wave 2 Up in the $SPX at 1363, and the chart for the last week of October 2011 of $SPX at 1292 is an Elliott Wave 2 of 2 up, and the chart for the second week of January of the $SPX again at 1292 is an Elliott Wave 2 of 2 double top up, with the result that the $SPX, traded by SPY, is going to enter an Elliott Wave 3 of 3 of 3 down for the week ending January 20, 2011 when options expire. These are the most destructive of all economic waves as they for all practical purposes destroy all economic wealth built on the five waves up. This coming down wave is going to take out even the yet to be established ten toed kingdom of regional global government, at which time the Sovereign will take the upper hand and establish a world one world government, with a one world currency and provide global seigniorage.
ReplyDeletePerhaps one might enjoy my linked article entitled The S&P Downgrade Of Nine European Nations Terminates The Age Of Liberal Finance And Commences The Age Of Sovereign Default ….. And Terminates Democracy And Commences Regional Global Governance
I believe that the last week of April 2011 commenced an Elliot Wave 2 Up in the $SPX at 1363, and the chart for the last week of October 2011 of $SPX at 1292 is an Elliott Wave 2 of 2 up, and the chart for the second week of January of the $SPX again at 1292 is an Elliott Wave 2 of 2 double top up, with the result that the $SPX, traded by SPY, is going to enter an Elliott Wave 3 of 3 of 3 down for the week ending January 20, 2011 when options expire. These are the most destructive of all economic waves as they for all practical purposes destroy all economic wealth built on the five waves up. This coming down wave is going to take out even the yet to be established ten toed kingdom of regional global government, at which time the Sovereign will take the upper hand and establish a world one world government, with a one world currency and provide global seigniorage.
Perhaps one might enjoy my linked article entitled The S&P Downgrade Of Nine European Nations Terminates The Age Of Liberal Finance And Commences The Age Of Sovereign Default ….. And Terminates Democracy And Commences Regional Global Governance
http://tinyurl.com/7fey9j3