Volatility Futures and Options (VIX) Overview
Volatility Futures and Options (VIX) Overview
VIX futures and options allow investors to trade market volatility directly, rather than indirectly through option spreads. The VIX, known as the "fear gauge," measures expected 30-day volatility of the S&P 500 based on option prices. VIX derivatives have unique characteristics that differ significantly from traditional equity and commodity markets.
Definition and Key Concepts
What Is the VIX
VIX (CBOE Volatility Index): A real-time measure of expected 30-day implied volatility of the S&P 500, calculated from a weighted blend of SPX option prices.
Key characteristics:
- Spot VIX is not directly tradable
- VIX futures and options settle to VIX at expiration
- VIX tends to spike during market stress
- Strong negative correlation with equity markets
VIX Futures Specifications
| Parameter | Specification |
|---|---|
| Underlying | VIX Index |
| Contract size | $1,000 × VIX futures price |
| Tick size | 0.05 ($50 per tick) |
| Settlement | Cash-settled |
| Expiration | Wednesday, 30 days before third Friday of next month |
| Trading hours | Nearly 24 hours |
| Margin | Variable (typically 30-50% of notional) |
VIX Options Specifications
| Parameter | Specification |
|---|---|
| Underlying | VIX Index (special settlement) |
| Contract size | 100 × option price |
| Strike intervals | 0.5, 1.0, or 2.5 points |
| Exercise style | European (exercise at expiration only) |
| Settlement | Cash-settled to VIX settlement value (VRO) |
Term Structure Behavior
| Market Condition | Term Structure | Description |
|---|---|---|
| Calm markets | Contango | Futures > Spot |
| Stressed markets | Backwardation | Spot > Futures |
| Transition | Flat | Spot ≈ Futures |
How It Works in Practice
VIX vs. VIX Futures
Key distinction:
- Spot VIX: Implied volatility right now
- VIX futures: Expected VIX level at expiration
Example (contango):
- Spot VIX: 15
- 1-month VIX futures: 17
- 2-month VIX futures: 18
- 3-month VIX futures: 19
The futures trade at a premium because volatility tends to revert toward long-term average (around 18-20).
Roll Cost in Contango
Monthly roll (typical contango): Front month expires at spot (15) Next month costs 17 Roll loss: (17 - 15) / 15 = 13% per month
Annual cost of maintaining long exposure: Approximately 30-50% in normal contango markets.
VIX Mean Reversion
Historical VIX ranges:
| Percentile | VIX Level |
|---|---|
| 10th | 12 |
| 25th | 14 |
| 50th (median) | 17 |
| 75th | 22 |
| 90th | 30 |
| Crisis peaks | 50-80 |
VIX spikes quickly during crises but tends to revert to 15-20 range.
Worked Example
VIX Futures Trade
Market conditions:
- Spot VIX: 14 (low volatility)
- 2-month VIX futures: 18
- Implied volatility for VIX options: 80%
Trade: Long VIX futures for tail protection
Position:
- Buy 10 VIX June futures at 18.00
- Contract value: 10 × $1,000 × 18 = $180,000
- Initial margin: $60,000 (33%)
Scenario analysis:
| Scenario | VIX at Expiry | P/L Calculation | P/L |
|---|---|---|---|
| Calm (spot unchanged) | 14 | 10 × $1,000 × (14 - 18) | -$40,000 |
| Normal (mean reversion) | 17 | 10 × $1,000 × (17 - 18) | -$10,000 |
| Moderate stress | 25 | 10 × $1,000 × (25 - 18) | +$70,000 |
| Crisis | 45 | 10 × $1,000 × (45 - 18) | +$270,000 |
The trade loses if VIX stays calm but gains significantly in a crisis.
VIX Call Option Trade
Alternative: VIX call spread for defined risk
Position:
- Buy 10 VIX June 20 calls at 3.00
- Sell 10 VIX June 35 calls at 1.00
- Net debit: $2.00 × 100 × 10 = $2,000
Outcomes:
| VIX at Expiry | Long 20 Call | Short 35 Call | Net P/L |
|---|---|---|---|
| 14 | $0 | $0 | -$2,000 |
| 20 | $0 | $0 | -$2,000 |
| 25 | +$5,000 | $0 | +$3,000 |
| 35 | +$15,000 | $0 | +$13,000 |
| 50 | +$30,000 | -$15,000 | +$13,000 |
Maximum loss: $2,000 (premium paid) Maximum gain: $13,000 (spread width minus premium)
P/L Attribution
In a crisis scenario (VIX 14 → 35):
| Component | Contribution |
|---|---|
| VIX level increase | +$15,000 intrinsic |
| Vega gain (vol of vol up) | +$1,000 |
| Time decay | -$500 |
| Net | +$15,500 |
Risks, Limitations, and Tradeoffs
Contango Decay
| Holding Period | Contango Cost (typical) |
|---|---|
| 1 month | 3-8% |
| 3 months | 10-20% |
| 1 year | 30-50% |
Long VIX positions are expensive to hold due to persistent contango.
Volatility of Volatility
VIX is highly volatile:
| Metric | S&P 500 | VIX |
|---|---|---|
| Daily vol | 1% | 4-6% |
| Monthly vol | 4% | 20-30% |
| Max single-day move | 10-12% | 100%+ |
VIX can double overnight in crisis scenarios.
Settlement Risk
VIX settlement value (VRO):
- Calculated at market open on settlement day
- Uses opening prices of SPX options
- May differ from prior day close VIX
- Can create significant gaps
Common Pitfalls
| Pitfall | Description | Prevention |
|---|---|---|
| Holding too long | Contango erodes position | Use short-dated options |
| Wrong expectations | VIX futures ≠ spot VIX | Understand term structure |
| Oversizing | VIX moves are large | Size for worst case |
| Ignoring settlement | VRO can gap from close | Exit before settlement |
| Selling naked | Unlimited loss potential | Always define risk |
Strategic Applications
Tail Risk Hedging
Structure: Rolling 2-3 month VIX calls Rationale: Crisis protection with defined premium cost Cost: 0.5-2% of portfolio annually
Spread Trading
| Strategy | Position | View |
|---|---|---|
| Calendar spread | Long back month, short front | Contango to persist |
| Call spread | Long lower, short higher | Moderate VIX spike |
| Put spread | Long higher, short lower | VIX decline |
Volatility Carry
Short VIX strategy (risky):
- Sell VIX futures in contango
- Collect roll yield as futures converge to spot
- Risk: Large losses in VIX spikes
Checklist and Next Steps
Pre-trade checklist:
- Check VIX term structure (contango/backwardation)
- Calculate roll cost for holding period
- Size position for maximum expected VIX level
- Choose between futures and options
- Set exit criteria (time or price)
- Document hedge rationale
Execution checklist:
- Verify contract specifications
- Check margin requirements
- Monitor settlement calendar
- Set up expiration alerts
- Plan roll or exit strategy
Ongoing monitoring:
- Track term structure changes
- Monitor spot VIX vs. futures
- Assess hedge effectiveness
- Evaluate roll timing
- Report to risk committee
Related articles:
- For variance swaps, see Variance and Volatility Swap Mechanics