Further understanding of VIX options

[Saltynuts]

I have a large number of June 20 calls on the VIX (which i bought when the VIX was in the low 9s, to offset potential losses in the XIV I hold when the VIX ultimately popped). Late last week or so the VIX took a POUNDING (to the upside) - from in the 11s to not that short of 20 now. My XIV went way down, but since VIX is now not very far out of the money, I had suspected my June 20 calls would act as a pretty good counter as VIX got closer and closer to a 20 strike price, and a very good counter over that since they are "in the money".

But my call options hardly increased in value. I think this is because June is still a long ways off, and these call options can not be exercised early (they are cash settled at expiration). So the once the VIX goes above 20, that doesn't mean that the option values for far off options will move more-or-less lock step - instead investors have to take into account that from the time today when they buy the option to the time in June when it is cash settled, even if VIX is (let's say) 24 today, it still has several months in which it could slip. So while the option has potential appreciation value, it also has potential depreciation value as well.

So I really wanted to hedge my XIV, I would want to buy much nearer-term calls.

Does that make sense?

Thanks!

 

[Robert Morse]

Saltynuts,

I have a few things to point out, How do you know the call trade was initiated by the buyer and not a seller? How do you know it was not tied to a trade in the futures or a roll from another month?

The June calls are priced vs the June VX Future, not the VIX cash. The JUNE Future close at 15.425 on 2.2/2018.

 

[beerntrading]

But my call options hardly increased in value. I think this is because June is still a long ways off, and these call options can not be exercised early (they are cash settled at expiration).

You're on the right track, but not quite. It's not the euro style exercise alone, it's actually the contango of the futures contract (presumably the very reason you're in XIV). But they don't have true 'intrinsic' value when the VIX goes 'ITM'--in short because there is no value that underlays it. But there's an expectation that this will revert back down prior to the June expiry--the only way that VIX options will exhibit price movement vs. the underlying similarly to equity options is when the expectation is that this will not come back down prior to expiry (i.e. people believe it will flat line from here).

All is not lost though, as long as you can swing the margin. If you don't mind holding this until June, you can wait till it reverts to lower values, and if it doesn't your calls will become worth something as they near expiry, and on expiry should be very close to you expected value.

I suspect that the trade will be a total loss from this point anyway since you're locked into it, and anything you pick up on XIV will be offset by the premium losses on the long calls...but you'll do better than trying to close it while the VIX has run away from you.

Chalk this one up to a lesson well learned for relatively cheaply.

 

[JSOP]

I have a large number of June 20 calls on the VIX (which i bought when the VIX was in the low 9s, to offset potential losses in the XIV I hold when the VIX ultimately popped). Late last week or so the VIX took a POUNDING (to the upside) - from in the 11s to not that short of 20 now. My XIV went way down, but since VIX is now not very far out of the money, I had suspected my June 20 calls would act as a pretty good counter as VIX got closer and closer to a 20 strike price, and a very good counter over that since they are "in the money".

But my call options hardly increased in value. I think this is because June is still a long ways off, and these call options can not be exercised early (they are cash settled at expiration). So the once the VIX goes above 20, that doesn't mean that the option values for far off options will move more-or-less lock step - instead investors have to take into account that from the time today when they buy the option to the time in June when it is cash settled, even if VIX is (let's say) 24 today, it still has several months in which it could slip. So while the option has potential appreciation value, it also has potential depreciation value as well.

So I really wanted to hedge my XIV, I would want to buy much nearer-term calls.

Does that make sense?

Thanks!

I apologize in advance if I appear a bit rude but it does not make sense. If you bought calls for an instrument that is going up in value, your calls would go up and eventually be in the money if the underlying goes higher than the strike REGARDLESS of the expiration date. The farther away the expiration date, actually the more valuable an option is because of the IV potential would be higher, and the higher the IV is, the more valuable an option is.

 

[i960]

I apologize in advance if I appear a bit rude but it does not make sense. If you bought calls for an instrument that is going up in value, your calls would go up and eventually be in the money if the underlying goes higher than the strike REGARDLESS of the expiration date.

Spot VIX doesn't matter for it's options unless we're talking near settlement or so. VIX options are really just options on futures - where said futures are the VX futures on CFE. I could go on forever about how badly designed this thing is (split exchanges), etc. but it's all been said before.

 

[Saltynuts]

Saltynuts,

I have a few things to point out, How do you know the call trade was initiated by the buyer and not a seller? How do you know it was not tied to a trade in the futures or a roll from another month?

The June calls are priced vs the June VX Future, not the VIX cash. The JUNE Future close at 15.425 on 2.2/2018.

Thanks Robert. I guess I'm not understanding your first questions. My understanding is that a VIX call option with a strike price of 20 will, on settlement, pay you the amount VIX exceeds $20 (times $100). What do you mean by "initiated by the buyer" versus "seller"? I bought it, so I hold the call option. Does it really matter who might have issued it and traded it before me? I'm sure I'm missing something here.

"The June calls are priced vs the June VX Future, not the VIX cash. The JUNE Future close at 15.425 on 2.2/2018." Are you just saying that the "market" pricing of the VIX options will be more tied to VIX futures rather than VIX cash? That seems reasonable. But I think upon payment, the question is what is VIX cash that day compared to your strike price - if it is higher your account gets debited the difference. Is that not right?

Thanks so much!

 

[beerntrading]

I apologize in advance if I appear a bit rude but it does not make sense. If you bought calls for an instrument that is going up in value, your calls would go up and eventually be in the money if the underlying goes higher than the strike REGARDLESS of the expiration date. The farther away the expiration date, actually the more valuable an option is because of the IV potential would be higher, and the higher the IV is, the more valuable an option is.

XIV is inverse VIX. And VIX options do not exhibit that type of ITM 'intrinsic' value behavior like equities options do. Far out from expiry, the VIX options have almost no sensitivity to the VIX itself unless there's a large move the market believes to be sustained.

 

[Saltynuts]

You're on the right track, but not quite. It's not the euro style exercise alone, it's actually the contango of the futures contract (presumably the very reason you're in XIV). But they don't have true 'intrinsic' value when the VIX goes 'ITM'--in short because there is no value that underlays it. But there's an expectation that this will revert back down prior to the June expiry--the only way that VIX options will exhibit price movement vs. the underlying similarly to equity options is when the expectation is that this will not come back down prior to expiry (i.e. people believe it will flat line from here).

All is not lost though, as long as you can swing the margin. If you don't mind holding this until June, you can wait till it reverts to lower values, and if it doesn't your calls will become worth something as they near expiry, and on expiry should be very close to you expected value.

I suspect that the trade will be a total loss from this point anyway since you're locked into it, and anything you pick up on XIV will be offset by the premium losses on the long calls...but you'll do better than trying to close it while the VIX has run away from you.

Chalk this one up to a lesson well learned for relatively cheaply.

Interesting. So to sum up the point you think I am missing - my VIX options will likely suffer the "contango" same or similar losses over time as my XIV, so if I'm "100% hedged", those losses might very well offset any gain in my XIV from the contango. But, at the end of the day, if VIX cash closes above 20, I get paid the difference *100 * # of contracts i have (thus, VIX closes at 30, I'd get paid 10*100*100 (contracts) = 100,000.

Sounds about right?

 

[Saltynuts]

I apologize in advance if I appear a bit rude but it does not make sense. If you bought calls for an instrument that is going up in value, your calls would go up and eventually be in the money if the underlying goes higher than the strike REGARDLESS of the expiration date. The farther away the expiration date, actually the more valuable an option is because of the IV potential would be higher, and the higher the IV is, the more valuable an option is.

The problem is I think you are forgetting one thing. Because it is euro exercise, a VIX call option might have a LESSER value the longer the expiration date pushes out. This is becuase (i) the contango effect, (ii) if the VIX is high, the expectation that it will revert down to its mean, and (iii) the fact that is euro exercise, you have to wait until expiration to exercise it. Thus if I have a VIX call at 35, and VIX is 37, and it is expiring it 2 minutes, the call should right around $2. But if that same call is expiring in 6 months, it might be WAY LESS than that since most investors believe the VIX will drop well below 35 by 6 months down the road (since its average/mean is well below that). So it could well be trading below $2.

Does that make sense? Of course, the potential for future VIX increases in the future might mean a longer term option has a higher value, but I think it could have a lower value as well for the reasons set forth above. I think that is what I was missing.

Thanks all!

 

[beerntrading]

Interesting. So to sum up the point you think I am missing - my VIX options will likely suffer the "contango" same or similar losses over time as my XIV, so if I'm "100% hedged", those losses might very well offset any gain in my XIV from the contango. But, at the end of the day, if VIX cash closes above 20, I get paid the difference *100 * # of contracts i have (thus, VIX closes at 30, I'd get paid 10*100*100 (contracts) = 100,000.

Sounds about right?

Yeah, pretty much. But, it's the Special Opening Quotation on expiry day (a good time to add, these are AM expiry)--it's symbol VRO. I'm a bit baffled that there isn't a good article written on this (ET is pretty near the top of the google searches).

Also, I'm not 100% clear on the relationship between XIV and VIX options--the chart isn't what I'd expect on the options vs. XIV. So I suspect there's a risk you have hanging out there that I'm not identifying. If I were you, I'd be figuring out what this risk was. I'm sure there's someone on here who understands XIV well.