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Vix Series

  • Guides
Aug 25

CBOE VIX trading and CBOE VIX options can be incredibly difficult. Technically, the VIX should represent one standard deviation of market returns for whatever period an index is calculating. The main VIX calculates 30 calendar days of implied volatility and interpolates options between 23 days and 37 days to expiry (remember not how it’s settled!). The spot price of the VIX is calculated on a minute to minute basis to keep up with the fast-paced markets. The CBOE Volatility Index is not an ETF, and it cannot be bought and sold, only futures and options contracts that derive their value from its price and time to expiry can be purchased. The index value acts as price mechanism, so if your strike price is $15 and the VIX is at $20 then your option's intrinsic value would be $5. Of course, in a real situation the intrinsic value would be supplemented by time value, the longer until expiry, the higher the time value.  Since the index is made of options instead of stocks, which makes things a little bit different, similarly to other indexes, options, not commodities, are selected by rules to make up the wider index. The actual components of the VIX are the near and next-term SPX options. In fact, because of how the VIX needs to roll-over based on its rules the number of options used to calculate the VIX may change from day to day or even minute to minute, particularly since traders can game it a little bit by bidding zero on a strike price and therefore getting excluded from the index at that moment since zero bid/asks are not able to be used in the formula. Volatility Term Structure: Getting Signals From CBOE VIX There are robust futures markets for the VIX. Futures contracts create curves similar to interest rate curves (think T-cure) which can tell us quite a lot about anticipated index value. CBOE VIX trading can only be done with either futures or options, but are settled in cash at an agreed-upon reading of the index. The properties of these markets can tell us a lot about how markets perceive the future, particularly in the event of an ongoing disaster. For instance, during the panicked selling in March when the VIX reached highs its curve was in backwardation which happens rarely in times of great tumult. What this literally means is that the market is expecting more volatility in the short-term, than in the long-term. One CBOE VIX trading strategy is to sell call options on the index when it is anomalously high. Any time the VIX is in backwardation, based on historical data, it will likely correct back to contango. Many engaged in CBOE VIX trading will use this strategy. This means that the market expects more volatility in the near term than the short-term. If you picture a curve of VIX futures going out into the future like an interest rate curve, that is how the term structure usually is shaped; in contango. This means the market, as would be generally the case, would expect more volatility as time goes on. Since the rise in stock prices further out maturities like Dec 20 and Jan 21 have started to normalize, but the VIX curve still shows potential for elevated risk around the election, which is also normal. When the VIX goes into full and normalized contango again, it will be a very positive sign for markets. Generally, when $VIX.X goes below $20 it is also considered a bullish market indicator.  Stock returns have been observed over time to negatively correlated with realized volatility and positively correlated with implied volatility. One thing you can do is get into the weeds and calculate a volatility index of some of your favorite stocks and then compare the volatility term structures to see how they diverge and how they are similar. There are also many new ETFs and ETNs that own primarily, or partially a lot of volatility assets. As you can see above, the VIX term structure has normalized but still has some elevated readings around the time of the election. Our Washington Analyst, L. Thomas Block, has provided some excellent analysis on what happens to the stock market during elections. We rely on him for assessing headlines with the benefit of a seasoned political operator. Based on our analysis, we don’t really get the glum sentiment on the street around the election. Other Volatility Indices The Chicago Board Options Exchange calculates several volatility indices and the VIX and the old VIX (VXO). They also calculate Cboe Short-Term Volatility Index (VIX9D) or nine-day expected volatility, it has the (VIX3M), (VIX6M) and (VIX1YR) which reflect the three month, six month and one-year volatility respectively. You can find more on the VIX and the white paper on valuation at  Quick Navigation on this series VIX Series - Part 1: What Is The VIX And How Does It Work? VIX Series - Part 2: What Is Volatility? VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIXVIX Series - Part 4: How To Read The Fear Gauge: VIX Value and How It's CalculatedVIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX) < PreviousNext >

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  • Guides
Aug 25

VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIX

For most of human history, if you were a victim of the regular fits and starts that affect commerce on Earth, you were pretty much out of luck. Of course, there were old versions of state bailouts every once and a while, but generally, the risk was not a very easy thing to manage. One lousy season or one bad storm could often ruin the farm or the business. This problem eventually led to the establishment of futures markets for agricultural commodities. The Chicago Futures Exchange (CFE) would pioneer many of the strategies that have become common in futures markets. These innovative instruments, which gave people an unprecedented ability to hedge risk, would forever change how business was done, and the risk was managed. Chicago, which was geographically positioned in the middle of America's heartland, would become one of the world's most critical commodities exchanges and innovation-centers for finance. The CBOE volatility index changed how volatility can be used and prepared for by investors. We’re not teaching you to how to trade the VIX, as this is very complicated and requires more than a few years of experience in derivatives valuation. We do, however, want to make you appreciate this complicated financial instrument that many investors perceive incorrectly. The Greek letter used for Implied Volatility in the Black-Scholes Options Pricing Formula is Sigma. Therefore, the first iteration of what would become the VIX be called the Sigma Index in an early paper published by Brenner and Galai in 1989. By 1993, the first version of the index, based on the S&P 100 (OEX) index, was formulated. This 'old VIX' is now under the ticker VXO. It was met with extreme demand from retail and institutional investors. The VIX is the CBOE's most popular product ever in a long list of popular and widely used financial instruments. Technically, the VIX is the volatility of a variance swap, not an actual volatility swap. This is for reasons of calculation because a variance swap can be more easily replicated through vanilla put options and call options. History was made when volatility could first be 'bought' and 'sold' as an asset. How to trade the VIX successfully is not easy though. By 2003, the methodology had changed, with the help of Goldman Sachs, and the VIX index option prices were now being calculated on the broader S&P 500. The actual number of the VIX should not be construed as a percentage, as that is inaccurate. However, the way the VIX is designed is to have its number interpreted as an implied volatility reading. Since the VIX is calculated from the price of SPX options, which is the best proxy for the broader American stock market, it is considered a macro-indicator. However, volatility indexes can be set up for any stocks; in fact, CBOE does them for many large caps. It uses a variant of the VIX calculation to create a similar index from each name’s options market. Other VIX calculations result in other indexes. VIX calculations are done in real-time. However, if you’re going to trade the VIX and intend to exercise, be sure to read up on the settlement rules. Many a trader who has thought they had a pretty sweet in-the-money position until they realized that the VIX is settled for exercise in an entirely different way than it is calculated in real-time. VIX options usually expire on Wednesdays as opposed to Friday, even though the underlying SPX options all still expire on Friday.  How To Trade The VIX This important index regularly fluctuates based on threats to market stability. Unlike single stock names, the price action in the VIX is very much a comprehensive picture of how markets feel. Trading this asset can be incredibly difficult since it can become very headline dependent. However, the thrust of our research is data so when top-down investing environments dependent on headlines develop we get right into the relevant data and give you useful insights for how to trade the VIX. As you can see, we have been monitoring different groups of stocks compared to daily cases and have been trying to keep our community one step ahead of the crowd. How to trade the VIX, you ask us? Always maintain an edge in the data and ahead of the competition and you will; be off to a good start.  Whether you’re a new investor or a sophisticated trader we believe you will find our analysis useful. Also, check out our industry-leading technical analysis by Rob Sluymer.  Quick Navigation on this series VIX Series - Part 1: What Is The VIX And How Does It Work? VIX Series - Part 2: What Is Volatility? VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIXVIX Series - Part 4: How To Read The Fear Gauge: VIX Value and How It's CalculatedVIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX) < PreviousNext >

  • Guides
Aug 25

VIX Series - Part 2: What Is Volatility?

You may have a negative connotation of the word volatility, and for a good reason. But what is volatility, really? It is usually in the common parlance most often when things are bad or expected to be soon. It’s an emotive word, but not necessarily in the financial context all the time, believe it or not. However, the word’s official definition doesn’t mean bad, or emotional. In finance, volatility is a less loaded term that simply means the change in price over a given amount of time. So, in a straightforward sense, it is just the actual price movement of an asset. Calculating historic, or realized volatility is usually a good way to determine the future price range of your asset, but not always. Over-reliance on historical data plagued institutions during the crisis. Stochastic risk models, Monte Carlo simulations, and  Regime Switching Rare Disaster models have been found to be effective ways to model volatility in addition to historical data. Relying solely on historic volatility can be very risky. Investors need something more than just past data to make the best decisions possible, and since Future or Options markets give a lot of information about the mood of investors, it is exactly what is used to derive the CBOE VIX. Many investors are familiar with the VIX, or they have been conditioned in a Pavlovian fashion to know one thing, the VIX going up suddenly and sharply usually means frantic selling and hard times. Think back to March.  We can all pause and think of a moment when we saw the VIX spike to a level that made us lose our breath for a moment, but so far, it is coming out of backwardation and moving toward more normal levels. Trading options or futures on VIX is tricky business, particularly if you're not highly experienced with options, and the effects on valuation and liquidity risk that come with owning European-style options, which can only be exercised at expiration opposed to at any time up until expiration are complicated. VIX is perhaps the most complex of the commonly cited indexes in how it is calculated. Unlike ETFs or stocks, you cannot simply buy and own the VIX. What Is Implied Volatility? Derivatives are assets that have their value derived from an underlying asset. Thus, their market prices are subject to much more wild swings as a result of the leverage these instruments utilize. You cannot buy and hold derivatives, like options and futures, because they have an expiration date. They give you the right to buy or sell a security or commodity at a previously specified price regardless of the underlying price. A call option is the right to buy a security at a certain price before a certain date, and a put option is the inverse, the right to sell. You can be short or long options, long meaning you have rights (to exercise or sell your option) and short meaning you have obligations, to purchase or sell the securities. The strike price determines how far away from the actual price, the option's value is. Options with strike prices closer to the actual price of the asset have higher premiums. This principle is the basis of Black-Scholes. When an options chain is following the model in real life you will be able to observe something called the ‘Volatility Smile’. This is the natural tendency of the implied volatility to go up, just as interest rates would on a curve with maturity. So, the further out of the money an option is, the high its implied volatility.   It is impossible to predict the future. However, we can make sense of the best information we have, coupled with assumptions. This is what Fisher Black and Myron Scholes did when they created their revolutionary options pricing model, The Black-Scholes Formula. Subsequent options pricing models have been developed to enhance and improve the original. However, implied volatility is the only factor of these models not directly observed in the market. In other words, implied volatility is derived through the model using other observable data. The higher an implied volatility, the higher the potential move in the premium of an option, and the underlying stock price. The inputs used to derive implied volatility are the European-style S&P 500 index for near term options with more than 23 days until expiration and next term options with less than 37 days as well as risk-free US T-Bill Rates, which are used as a proxy for the input of the risk-free interest rate. One important thing to remember about implied volatility is that it does not determine which direction an asset will move in price. It only has a high probability of moving away from the current price. This metric tries to approximate the future value of the option using the available information at hand. So, primarily to find a stock's implied volatility, you would work backward from the Black-Sholes inputs. This is important to remember because the model is based on assumptions that sometimes deviate from actual market conditions. So, it is important to remember that implied volatility is not predicting the future, just giving the best indication of its probability that we can find. Due to the centrality of agriculture in early derivatives trading, Chicago and the Chicago Board of Options Exchange (CBOE) became key to the development of the financial industry. One of its biggest contributions to finance and markets was the volatility index. What is volatility? It is something that can now be traded, managed, and hedged better than at any time in previous world history. Whether you are buying VIX options or futures, or maybe getting some exposure through an ETF or other passive vehicle, you can significantly mitigate your downside loss when volatility rears its ugly head when you use all the tools the market has to offer. Source: CBOE Quick Navigation on this series VIX Series - Part 1: What Is The VIX And How Does It Work? VIX Series - Part 2: What Is Volatility? VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIXVIX Series - Part 4: How To Read The Fear Gauge: VIX Value and How It's CalculatedVIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX) < PreviousNext >

  • Guides
Aug 25

VIX Series - Part 1: What Is The VIX And How Does It Work?

“A good forecaster is not smarter than everyone else, he merely has his ignorance better organized.” -Anonymous  This recent crisis saw the Chicago Board Options Exchange (CBOE) Volatility Index closing at its highest level in history, above $82. But, many may ask themselves what is the VIX? What does a closing reading of 82 even mean?! This is the highest closing reading for stock market volatility ever. The market has now retraced all of its losses since that time and made a new all-time high (ATH). However, due to the uncertainty associated with COVID-19, VIX levels remain elevated relative to historic norms. We believe they will soon decline to levels that will attract a lot of the $5 trillion in capital on the sidelines. One of the reasons investors are so skittish is because of the extraordinary pace of the virus-driven drop in March. The market lost a lot quicker, but as we predicted in the heat of the March lows, a ‘V-shaped’ stock market recovery would follow and we would soon retrace and even achieve new highs. Still, the VIX recently hit levels higher than it has ever in its now substantial history, and once you know what the VIX actually means, it may seem even more peculiar to you. This extraordinary number, shown above, surpassed even the highest close during the financial crisis. You might have heard of the Volatility Index, or VIX as it's known by shorthand; most investors know that they at least see it flashing higher when things go bad. However, the VIX is an important market signal to understand. We would like to make it an even more valuable tool during a time of high uncertainty. What does the number mean? If the VIX is at 25 today and let's say the market is at 100 (for ease), then the stock market believes within a 68% confidence level that the market will be within $75 and $125 in 1 month. This is what the VIX tells us, and though it cannot predict the future, the action in options markets is often predictive.  What is market volatility? What is market volatility? What is market noise, and are they different? How can we tell when it's just normal volatility or a secular directional change? In statistics, noise is irrelevant data, and signals are the pieces of information that illuminate truth. In this spirit, our Chief Editor Vito Raccaneli runs a column called “Signals From The Noise” in which he regularly provides single name stock picks with actionable price targets and unlike many competitors, a section where he candidly explains where he could be wrong. For those concerned about market volatility he also ran a superb webinar on using covered calls, the lowest risk derivative strategy that all stock-owners should know, to help stabilize returns and income during periods of heightened uncertainty like we currently face. Many different data are continually being assessed by investors and the machines that do their bidding. Option prices have proven one of the most significant pieces of this information in managing risk.  There are so many different index options these days, but perhaps none is as famous and ominous as Wall Street's well-known 'fear index'.   We’ve all heard fear index, and we all know the VIX goes up when things are volatile, but what is the VIX, exactly? Most of the constant flow of information is nothing but noise, however, buried deep within these copious data points, and headlines are hints to what will happen in the future. We have to determine which is more critical when selecting the important signals from the noise—deciding which is signal and which is noise is what makes the difference between who makes money and who loses money. Luckily, over the past decades, new and exciting tools like VIX have proliferated, which calculated the implied volatility of S&P 500 index options to arrive at a number that expresses implied volatility. This number should now be less ‘noisy’ to you. You cannot buy the VIX index because it is interpolated from a wide range of strike prices on the stock market. It is literally the market's expectation of 30-day volatility for the broader index based on the difference between put options and call options. Mohammed El Erian, in his 2007 book When Markets Collide, recounts the story of a trader he started working for in London who had a higher level of 'street smarts' than some of the other newer analysts at the time, including El-Erian. On average, market days, he would regularly solicit the fundamental-driven views of the better-studied analysts. On days when the market was experiencing turmoil, he would instruct all the newbies, sometimes aggressively, to stay as far away from his desk as possible to avoid becoming confused by some fundamental analysis that was irrelevant to the days' exciting market action. This trader, it appears, was trying to keep the noise out. Even though, under different circumstances, that noise might have been useful information. Unfortunately, much of this comes down to experience, training, and a firm grasp of financial mathematics. If you’re new to investing, you could probably use a little understanding of things like volatility and how to hedge against it.  Even if you’re a veteran investor you may still find yourself wondering what is the VIX? We bet you could use a little refresher on volatility and some of the most popular ways it is measured. We have written this piece for all skill levels. Hopefully, we can help turn the famous Volatility Index, widely known at perhaps a disservice to the investor, as the market's fear gauge. It would probably make a little more sense to most investors if you called the VIX what it is, the 30 day implied volatility of the S&P 500. This is where it gets its gloomy moniker because implied volatility is measured in the price of options on the most important index. Generally, people want to purchase put options when uncertainty, or fear of an unknown outcome, is higher.  Quick Navigation on this series VIX Series - Part 1: What Is The VIX And How Does It Work? VIX Series - Part 2: What Is Volatility? VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIXVIX Series - Part 4: How To Read The Fear Gauge: VIX Value and How It's CalculatedVIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX) Next >

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Aug 25

VIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX)

Trading VIX futures and VIX options can be incredibly difficult. Technically, the CBOE Volatility Index should represent one standard deviation of market returns for whatever period an index is calculating within a 68% confidence interval. If you were to increase the confidence interval, the number would also increase, for example, a VIX reading of 22 would be higher with a 96% or 99% confidence interval. The main CBOE Volatility Index calculates 30 calendar days of implied volatility and interpolates options between 23 days and 37 days to expiry (remember not how it’s settled!). The spot price of the VIX is calculated on a minute to minute basis to keep up with the fast-paced markets. The CBOE Volatility Index is not an ETF, and it cannot be bought and sold, only futures and options contracts that derive their value from its price and time to expiry can be purchased. The index value acts as price mechanism, so if your strike price is $15 and the VIX is at $20 then your option's intrinsic value would be $5. Of course, in a real situation the intrinsic value would be supplemented by time value, the longer until expiry, the higher the time value.  Trading volatility is hard though. Especially in times like these when market movement may be dependent on completely exogenous data, like how we have all had to become amateur epidemiologists to have any hope of investing success on shorter time horizons. However, if you have the stomach for it, then we will certainly be able to help you. These charts above show some of the in-depth analysis and monitoring of virus data that we do every single day for our clients. As you can see, based on our previous analysis of the infection curve in the New York/Tri-state outbreak, which caused the stock market collapse in March, we see a different narrative developing around where cases will go then is being represented in the wider media. There is no conspiratorial allegation here, we simply think we do data analysis of the highest efficacy that often exceeds what is available to much of the mainstream public. We crunch the numbers on virus data every day, keep our eye out for discrepancies, and provide timely and actionable advice to our members.  Since the index is made of options instead of stocks, which makes things a little bit different, similarly to other indexes, options, not commodities, are selected by rules to make up the wider index. The actual components of the VIX are the near and next-term SPX options. In fact, because of how the VIX needs to roll-over based on its rules the number of options used to calculate the VIX may change from day to day or even minute to minute, particularly since traders can game it a little bit by bidding zero on a strike price and therefore getting excluded from the index at that moment since zero bid/asks are not able to be used in the formula. Volatility Term Structure: Getting Signals From CBOE VIX There are robust futures markets for the CBOE Volatility Index. Futures contracts create curves similar to interest rate curves (think T-cure) which can tell us quite a lot about anticipated index value. The properties of these markets can tell us a lot about how markets perceive the future, particularly in the event of an ongoing disaster. For instance, during the panicked selling in March when the VIX reached highs its curve was in backwardation which happens rarely in times of great tumult. This means that the market expects more volatility in the near term than the short-term. If you picture a curve of VIX futures going out into the future like an interest rate curve, that is how the term structure usually is shaped; in contango. This means the market, as would be generally the case, would expect more volatility as time goes on. Since the rise in stock prices further out maturities like Dec 20 and Jan 21 have started to normalize, but the VIX curve still shows potential for elevated risk around the election, which is also normal. When the VIX goes into full and normalized contango again, it will be a very positive sign for markets. Generally when $VIX.X goes below $20 it is also considered a bullish market indicator.  Stock returns have been observed over time to negatively correlated with realized volatility and positively correlated with implied volatility. One thing you can do is get into the weeds and calculate a volatility index of some of your favorite stocks and then compare the volatility term structures to see how they diverge and how they are similar. There are also many new ETFs and ETNs that own primarily, or partially a lot of volatility assets.  Quick Navigation on this series VIX Series - Part 1: What Is The VIX And How Does It Work? VIX Series - Part 2: What Is Volatility? VIX Series - Part 3: Chicago Board of Options Exchange (CBOE) Builds The VIXVIX Series - Part 4: How To Read The Fear Gauge: VIX Value and How It's CalculatedVIX Series - Part 5: How To Trade (And Read) The CBOE Volatility Index (VIX) < Previous

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