Author's note - over the weekend I discussed the price behavior of VIX futures and options into monthly settlement. I start this blog off restating the idea behind this sort of trade and then follow up with the outcome based on Tuesday closing prices and today's August VIX Settlement of 14.78.
Something I have been watching for some time is the futures pricing relative to spot VIX the Friday before settlement. The spread, when very little is going on, is usually about a point of premium in the soon to expire VIX future relative to the index. As noted above, the August VIX futures settlement was well over a point higher than VIX on Friday. This means if VIX does not move at all between Friday’s close and Wednesday's settlement (I know, a reality stretch, but work with me here), a short position in the future would result in a profit. This trade can also be done through purchasing VIX put options as VIX option pricing reflects the level of the underlying futures contacts. I decided to take a look at several August VIX Put option prices from the close on Friday.
The pricing above is the offer price at the end of the day Friday, along with a break even at expiration, and finally the difference between the break-even level and where VIX closed Friday. As an example the VIX Aug 17 Put was offered at 2.90. Purchasing this option with the intent of holding it to expiration would mean that august VIX settlement would need to be under 14.10 for this trading to make money.
Note the payoff at expiration in the diagram above results in a profit as long as VIX remains around current levels into Wednesday settlement. This is common when expiration is approaching, which is currently once a month. However, beginning in early October, CBOE will begin offering VIX options that expire each week. I’ll be watching closely to see if this sort of price behavior is as consistent with Weeklys as it has been with standard VIX futures and options.
I'm going to address two different potential outcomes based on buying VIX August Puts on the offer price on last Friday. The first involves exiting the position using the bid price for each option from Tuesday's close and the second involves holding the position through today's settlement.
The prices and losses (there were no gains) in the table bellow are based on paying the offer last Friday on the close and selling on the bid price on the close Tuesday. As VIX settlement can differ greatly from the previous day's closing level, especially if the equity market sells off, many traders like to exit positions instead of holding them through settlement.
Note that each trade is a loss, but a pretty small loss considering VIX rose almost a point from 12.83 to 13.79 from Friday to Tuesday.
The second outcome was much worse than the first. This morning August VIX settlement came in at 14.78 as equity markets were under pressure. This is a risk associated with AM settlement and is accentuated by the volatility of VIX, especially when stock prices are lower.
Any put with a strike below the settlement value of 14.78 ended up out of the money and a purchase of those puts based on Friday's close would have resulted in a loss equal to the premium paid. The higher strike, in the money options, have some value, which offsets the potential cost of those options from Friday.