Tuesday, September 22, 2009

Lessons Learned from a VIX Put Matrix

Each expiration cycle I typically take a gander at VIX options in an effort to find potential plays. As I've mentioned previously, I like the higher probability inherent with selling puts (particularly on a mean reverting underlying such as the VIX) vs. making a speculative play by buying OTM calls.
Before I jump into VIX options, let's take a brief moment to survey the current volatility landscape:

30 day historical volatility on the SPX sits at 16% - a level it's been parked at for about a month. Although it could certainly go lower, it seems to have found a suitable home for now.
Cash VIX currently sits around 23.5. As you can see in the graphic below, the cash VIX has been reticent to probe below 23 over the last 2 months.
October VIX futures are at 26.25.
November VIX futures are at 28.
[Source: EduTrader]

OptionsXpress provides a great view of the various expiration months and strikes to choose from via its Put and Call Matrix. Take a look at the Puts Matrix below (click on image to enlarge):

[Source: OptionsXpress]
Interesting Observations:

The Oct 25 strike put is trading for more than the Nov 25 strike put. The difference is even more pronounced in the further ITM strikes (27.50, 30). On any other put matrix for normal equity options longer term options are always more expensive due to the fact that November has more time premium than October. So why do we have this interesting price structure with VIX options?

1. Mean Reversion- If option traders believe the VIX is currently too low and its mean is higher than current VIX prices, then it stands to reason that the VIX should revert back to higher prices over time. Thus, VIX option traders will use higher prices in pricing VIX options for longer dated months. If that weren't the case and 23.50 (current cash VIX) was used to price the options in all months, then it certainly would not make sense for October puts to be more expensive than November.

2. VIX Futures- In answering the question as to where traders believe the VIX will be at later dates, we can look to VIX futures. Indeed, the underlying for VIX options is not the cash VIX, currently at 23.50, but VIX futures. When you use the futures price, the pricing on VIX options makes a lot more sense. Consider the following:

Oct VIX Futures = 26.25, Oct VIX 25 put = $1.30
Nov VIX Futures = 28, Nov VIX 25 put = $1.20

Although the November put has one more month of time, the expected price of the VIX in november is 28, making the 25 strike put $3 OTM; whereas the October 25 strike put is only $1.25 OTM.
For other related posts on the VIX, check these out:
Gaming Time and Volatility


Anonymous said...

Hi Tyler,
I think you mean more than...
The Oct 25 strike put is trading for less than the Nov 25 strike put

Tyler Craig said...

Good Catch Anon...

That was a dumb mistake. I meant more than-


Colorful chart