Quote from dmo:
Right. To add a little detail: vix options are European-style, exercisable only at expiration. Between now and then, the only underlying instrument available for delta hedging, gamma scalping, locking in profits etc. is that month's futures contract, which will settle at the same price as the options.
So for all practical purposes, the futures contract is the underlying for the options. The market recognizes that, and prices the options based on put-call parity with respect to the futures, not the cash.
As a result, the IV of vix options should be calculated using the futures contract as the underlying. Unfortunately, TOS, IB and probably other data providers calculate IV using the cash index as the underlying, which yields useless IV information. Another reason I do my options analytics with Excel add-in functions such as Hoadley; that way I can set things up correctly.
But while the market recognizes the futures as the underlying for the vix options, the regulatory authorities do not. That's mainly due to the split between the SEC and CFTC. Vix options are considered equity products and are regulated by the SEC; vix futures are regulated by the CFTC. This gives rise to the very annoying situation that there is no cross-margining between vix options and futures. You will pay the same margin on a losing futures position whether you have an offsetting options position or not.
There is something to what you say. The vix is different from, say, the SPX in that it is essentially mean-reverting. That mean may change, but it's pretty certain that the vix will not behave like a stock or stock average. The DJIA rose steadily from 41 in 1932 to some 14,000 over a period of years. You won't see anything similar happen with the vix, which represents emotion, which cycles up and down. So if you short the vix above 60, it's pretty certain the pendulum will eventually swing the other way.
That said, the devil's in the details. In the '87 crash - if there was a vix - it would have risen to about 150. Until the recent introduction of vix mini futures, the vix futures were $1000 per point. So if you shorted the futures at, say, 40 and they rose to 120, you would be looking at upwards of $80,000 per contract just to hang on. And there's no guarantee that those futures would drop back down to your buy point by expiration.
The fact that the futures lagged so far behind cash when the vix spiked to 90 or so represents the fact that a lot of people were thinking like you - that shorting the vix was easy money. That of course made it less easy.
