Explaining VIX Price Behavior Using the Insurance Analogy

When we introduce aspiring option traders to the various pricing factors that determine the value of an option contract we often use an insurance analogy to describe implied volatility. The short version of the story is that implied volatility is the pricing factor that is closely associated with the risk of price movement in the underlying market.  We expand on this idea using the idea of the cost of homeowner’s insurance as a hurricane is bearing down on south Florida. If a homeowner has forgotten to renew their homeowner’s insurance they are going to find the policy cost as a hurricane is approaching their home much higher than during a period of calm weather. This increased cost is a function of higher risk of the home being destroyed in the near future. Stock option prices usually move higher in front of anticipate price moving events such as a new product announcement or earnings report. This increase in the option premium is associated with higher implied volatility much like the higher insurance policy premium is a function of higher risk for policy seller.

VIX is a consistent measure of 30 day implied volatility as indicated by S&P 500 Index (SPX) option pricing.   VIX has moved in the opposite direction of the S&P 500 about 80% of trading days over the past few years.  A very common question is, “why do VIX and the S&P 500 move in opposite directions?”  I’ve been thinking of ways to describe the ‘why’ behind this behavior in relation to the insurance analogy we use with respect to implied volatility.

With the description of higher implied volatility in relation to the cost of a homeowner’s policy the participants in the contract know a hurricane is on the way.  That’s why the insurance company would charge more for the homeowner’s policy and the unhappy homeowner would expect to pay up for protection.  We also tend to have a good idea of pending events that will move an individual stock price.  With the overall stock market it is not as easy to anticipate events that will move the markets.

Think of the reaction of VIX as if there were no way to forecast the weather other than what the weather is doing at the current moment. Before a hurricane hits there is usually heavy rain and a thunderstorm. Without a forecast of what is next, people living in south Florida may over prepare each time there is a bad storm.  If all they have to judge that a hurricane is on the way is the current weather there is no way of knowing if this the time the storm is the beginning of something worse.

In the financial markets when the S&P 500 shows some weakness portfolio managers may be uncertain if even a minor sell off is the beginning of a bigger move to the downside.  Based on this concern managers often seek portfolio protection through purchasing S&P 500 put options. This increased demand results in higher implied volatility as indicated by higher SPX option premiums. This translates into higher VIX. On the other side of the equation, when the markets are moving higher or are a little stagnant, managers may not be as aggressive when seeking portfolio protection which would translate into VIX moving down.

Last Week in VIX – 12/28/2014

On Friday VIX rose as the S&P 500 hit the 52nd record high of 2014. I got a question via Twitter about VIX rising when the S&P 500 rises. About 20% of trading days witness VIX and the S&P 500 moving in the same direction, but when the S&P 500 is making a new high it may turn some heads. I think part of the small rise in VIX on Friday may be attributed to the holiday impact on the VIX calculation. What I mean by that is when we closed Wednesday the markets were closed for a day and a half. The VIX calculation only takes calendar and not trading days into the equation. This causes VIX to be under a little extra pressure in front of weekends and more so in front of long weekends. A bit of the upside in VIX on Friday may be attributed to the holiday being behind us. What makes me pause a little is that VIX closed Friday at 14.50 when the average VIX close this year on S&P 500 record days is 12.48 this year. VIX two points higher than that average as we make another new high would be more concerning to me than the rise of VIX on Friday.

VIX SPX Record Dates

The VIX did drop about 12% or 2 points last week as the S&P 500 moved higher. Despite the 12% drop in VIX the January VIX future was down about 1/3rd as much as VIX. A week ago there was no real risk premium in shorting the January future, over the course of 3 ½ trading days that premium returned.

VIX Curve

Last Week in Volatility Indexes and ETPs – 12/28/2014

This past week the S&P 500 recorded a record high on 3 of the 4 trading days with Friday being number 52 in 2014. I did some digging on this topic and 52 new highs in a year is less than the number of new highs just last year. Last year the S&P 500 set 69 new highs, but that still isn’t the record number of new highs in a single year. 1995 holds that distinction with the S&P 500 closed at a record level 77 times.

The term structure curve is returning to normal based on the price action in the S&P 500 last week, but still elevated relative to record S&P 500 days. VXST is seeing some extra pressure due to the holiday this coming week.   The longer end of the curve shifted lower, but not nearly as much as the drop in VIX and VXST. I also added a third curve here to compare volatility on the 52 days the S&P 500 closed at a record high this year with Friday’s close. Note the purple line is much lower than Friday’s closing curve.

VXST - VIX - VXV - VXMTI left the year to date information on this table this week as I wanted to point out the performance of SVXY this year.   SVXY is one of the two very actively traded funds that match the daily short performance of a portfolio that is short the front two month VIX futures contracts. Conventional wisdom in the financial markets is that selling volatility is like picking up nickels in front of a steam roller. As of Friday SVXY was up just over 1% for 2014. Anyone that held SVXY for all of 2014 earned that 1% as on February 5th the fund was down 24% and over the course of 2014 SVXY has experienced a drawdown of over 40%.

Index ETP Table

There was at least one VXX trader looking for steady to lower volatility into next year. About 30 minutes after the market opened on Wednesday someone came in and sold more than 10,000 VXX Jan 32 Calls at 0.93 and bout the same number of VXX Jan 36 Calls for 0.52 and a net credit of 0.41. VXX finished the day at 28.31 so this trade is safe as long as VXX does not move up more than 13% by January 16, 2015 or over 32.00. In the VIX world that’s just one good day for VXX and one bad day for the S&P 500. The worst case scenario is for VXX over 36.00 at expiration which would result in a maximum loss of 3.59.



VIX and the Santa Claus Rally

A couple of days ago JJ Kinahan from TD Ameritrade and a good friend of The Options Institute wrote a blog for Forbes.  His blog was about the period of time between Christmas and New Year’s. In the financial markets world this is considered a bullish time for stocks and is often called the Santa Claus rally. His comments can be found at the link below.


Since everything I do begins and ends with VIX I decided to take a look at what VIX has done each year over this time period. I was honestly surprised by the results. I took the VIX closing price the day before Christmas and the closing price on the last day of the year for each year from 1990 to 2013.   If the expectation is that stock prices move higher over this time period, then we would also assume that VIX would be moving lower. That assumption made me do a double take when I complied the table below.

VIX Santa Rally

Note that only three of the twenty four years on this table saw VIX move lower. Part of this may be attributed to the holiday impact on VIX where some of the value drops due to an extra day and a half off for Christmas. However, there are several double digit gains on the table above and that’s more than just the extra days off. As President Reagan use to say, trust but verify. This time the verification process yielded some interesting results.

Trade Looking for Lower VIX into 2015

December VIX settlement was last week and traders are starting to look to next year. Late Monday afternoon one of these traders took a position looking for VIX to return to the low teens in early 2015.   With VIX around 15.70 and the January VIX future at a 0.75 premium to the index at 16.45 a trader came in and bought a Jan VIX 14 / 15 Put Spread. The specific trade was a purchase of 4500 of the VIX Jan 15 Puts at 0.95 and sale of 4500 VIX Jan 14 Puts at 0.46 and a net cost of 0.49. The payoff at expiration for this bear put spread appears below –

VIX po

January VIX settlement at or below 14.00 will result in a gain of 0.51 on this spread. A partial profit may result from settlement between 14.00 and 14.51. Over 14.51 this trade starts to turn into a loser with a maximum loss equal to the 0.49 paid for the spread.

Oil VIX Is Up 209% and Brazil VIX Is Up 45% in 2014 Y-T-D – By Matt Moran

Dec. 22, 2014 – During the financial crisis of 2008, many investors bemoaned the fact many asset classes fell as the correlations among several asset classes rose. Since 2008 investors have searched for investments that have diversification potential in times of market stress.

So far in 2014 (through December 22) –

  • The CBOE Crude Oil ETF Volatility Index (OVX) is up 209%,
  • The CBOE Brazil ETF Volatility Index (VXEWZ) is up 45%, and
  • Crude oil prices are down about 44%.

Here are the highest daily closing values in 2014 –

  • The CBOE Crude Oil ETF Volatility Index (OVX) closed at 57.55 on Dec. 15 as oil prices plummeted (the average daily close for the OVX this year is only 22.3), and
  • The CBOE Brazil ETF Volatility Index (VXEWZ) closed at 72.83 on October 20, before the presidential election in Brazil (the average daily close for the VXEWZ this year is 31.3),

Futures and options are available on the OVX, VXEWZ, VIX, and other volatility indexes; investors are urged to study the pricing and settlement features of volatility instruments before investing.

01--Oil OVX Global

1-1 VIX1-2 SKEW & VVIX


So far this year, the average daily closing value for the VIX Index was 14.1, and some observers have asked if VIX has been somewhat low in light of all the worldwide geopolitical uncertainties and tensions in 2014. During the years 1990 through 2013, the average daily closing values were 20.2 for VIX and 117.2 for CBOE SKEW Index. So far in 2014, the average daily closing values were 14.1 for the VIX Index, 10.6 for the (20-trading-day) historic volatility of the S&P 500 Index, and 129.7 for the CBOE SKEW Index. So while the VIX recently has been below its long-term average, it is worth noting that the historic volatility of the SPX usually has been even lower than the VIX in 2014, and in 2014 the SKEW Index has been about 12 points above its long-term average. So in 2014 one might infer that the demand for out-of-the-money SPX puts (and disaster insurance) probably has increased relative to demand for at-the-money SPX options.


In the table below with 22 volatility indexes, four of teh indexes have risen more than 40% this year, but four of the indexes are down so far this year.  02-Table OVX Dec 22


CBOE Holdings offers many tools to manage portfolios in times of changing volatility. For more information on the indexes above, please visit www.cboe.com/volatility.

Last Week in VIX – 12/21/2014

The first chart in this blog is a bit out of place. I normally discuss the VXST – VIX – VXV – VXMT term structure in the space where we review volatility index and ETP trading. However, after I completed that blog I considered taking a look at where we closed Friday versus the average for 2014. On the short end VXST is only 0.07 higher than the average for 2014, but this can still be considered relatively high since we are moving into a holiday shortened week. Volatility indexes are calculated based on calendar days and when there are market holidays it creates some downside pressure. This pressure shows up even more in VXST since it is measuring eight day implied volatility.   The rest of the curve is pretty elevated relative to this past year which, if correct in the extra concern, may not be a good sign for stocks in the first half of 2015.

VXST - VIX - VXV - VXMT 2014 Comparison

The VIX curve returned to normal for the holidays as the S&P 500 rallied 3.41% last week. January is almost at parity with VIX which indicates no risk premium was being paid to for VIX futures sellers or that there is little expectation of VIX moving up from current levels over the near term. I know that directly contradicts the first paragraph in this blog, but the markets probably don’t expect much over the next couple of (holiday impacted) weeks.

VIX Curve

Wednesday was December VIX expiration so the focus is all on 2015. One trader is looking to a VIX settlement in the teens or lower come January 21st.   Just a few minutes after the open on Thursday, with VIX at 17.15 and the January VIX future around 17.65 there was a broken wing butterfly that caught my eye. A trader sold the VIX Jan 15 Put at 0.89 and sold the VIX Jan 15 Call for 2.89. They completed this spread through purchasing a VIX Jan 14 Put at 0.48 and VIX Jan 23 Call at 1.05. The result is the payoff that shows up below –


Note that January VIX settlement anywhere below 17.25 results in a profit for this trade, the perfect storm is VIX settlement at 15.00 and a profit of 2.25.   Any settlement below 14.00 results in a payout 1.25. The risk to this trade is a similar situation to December with January VIX settlement at 23.00 or higher. In this case this broken wing butterfly would result in a loss of 5.75.

Last Week in Gold and Oil Volatility – 12/21/2014

Gold volatility represented by GVZ dropped 5% last week and the price of gold as represented by GLD was down 2.25%. Now on to what people care about these days –

The week over week price change for the United States Oil ETF (USO – 21.96) comes nowhere near telling the story from last week. From Friday to Friday USO was up 0.03 from 21.93 to 21.96. So why in the world is the OVX curve in backwardation and why was OVX up over 10% to close over 50.00 for the first time in over 3 years? Why, when I ask rhetorical questions do I automatically think of Aliens?

The reason for elevated OVX has to do with the path USO took last week. Twice last week, Tuesday and again on Thursday, USO was down over 6% for the week. That sort of price action will get traders on edge and that shows up in the term structure chart below.


At least one trader is expecting a rebound in the price of oil as represented by the performance of USO. Relatively early on Friday there was a trader who purchased over 10,000 USO Apr 26 Calls at 0.72 who also sold 10,000 Apr 30 Calls at 0.22 for a net cost of 0.50. To reach the maximum profit of 3.50 this trade needs to see USO gain 36% over a four month period.  I decided to look back four months and back in August USO was in the mid-30’s. Although it appears to be a pretty big move, relative to how the price of oil has moved lately and the market outlook based on the elevated levels of OVX it is not out of the realm of possibilities.


Last Week in Volatility Indexes and ETPs – 12/21/2014

Santa Claus did not disappoint and his annual rally took the S&P 500 up 3.41% last week.   That move took the air out of the four S&P 500 related volatility indexes with VXST leading the way and losing over 40%.   The curve shift formed the week over week ‘horn’ which I guess is appropriate for the season.


Sticking with a theme I’ve been all over this quarter the S&P 500 is only a few points from setting another record high. Despite this high level of the S&P 500, VIX is at 16.49 is over 2 points higher than the average close for 2014.  This  shows that despite this week’s monster rally concern remains in the pricing of SPX option. Another volatility index that is at high levels is the VIX of VIX. VVIX closed at 99.17 which is the middle of the historical range, but much higher than levels we have become accustomed to in this bull market. The chart below shows the daily prices for VVIX in 2014.

VVIX Daily 2014

I publish the table below each week, but leave out the far right column.  The main reason I do not include the year to date numbers is because I think year over year performance is useless when looking at volatility indexes.  However it is useful when looking at the ETPs.   I wanted to include it this week to show something that is interesting about the performance of the various ETPs in 2014. Note as of Friday all the volatility oriented exchange traded products have lost value in 2014. This is a function of the leveraged long and inverse funds both matching daily performance with compounding coming into the equation when we experience volatility events to the upside or a quick move lower. The trade example from Friday shows that at least one trader does not expect all the funds to be lower for long.

Index ETPs

Friday morning someone came in and did a spread trade that appears to be bearing on VIX which of course is bullish on the stock market. The trade is bullish on SVXY which is designed to return the inverse of the daily returns that one would get from VXX. Therefore, low volatility is good for SVXY, low volatility in VIX normally comes from a bullish stock market move.

I’ll go slow, because there are many moving parts here, but when SVXY was trading at 64.30 there was a seller of SVXY Jan 17th 80 Puts for 15.99 who also bought the same number of SVXY Jan 17th 60 Calls at 8.23 and a net credit of 7.76. The payoff diagram below is a good depiction of what the end goal is for this trade –

SVXY PO Diagram

The goal is to have SVXY as high as possible on January 17th of next year, but as long as SVXY is higher than 66.12 the trade make some sort of profit. Being short the 80 put and long the 60 call results in a 2 for 1 point move between 60 and 80. Once the put is out of the money, the call continues to move higher on a 1 for 1 basis. The risk is a quick move higher in VIX that takes the front two month futures contracts along with it.

Last Week in VIX – 12/14/2014

Nothing like a 3% drop to provide a year-end boost to VIX, especially when it appeared no one was expecting it. Last Friday we got through the employment report unscathed and the result was a VIX close under 12. The last potential big “known unknown” this year comes Wednesday afternoon with the FOMC announcement. As a friendly reminder, December VIX futures and options settle on the open Wednesday so any trades based on an FOMC announcement reaction should focus on January contracts.

The curve went from textbook contango to backwardation (when looking at the index and front two month futures). Do note that the farther dated contracts were up over 10% across the board last week. This shows there is a shift in longer term thinking about the health of the US equity markets. So far in 2014 the average closing price for VIX has been around 14. The farther part of the curve indicates the average in 2015 is expected to be higher than in 2014.

VIX Curve

On Wednesday this past week VIX was up 20% on the day rising from 15.35 to 18.53. The December future rose from 14.90 to close at 17.40 that day as well. Someone correctly decided that the upside move was not over and just a few minutes before the 3:15 closing time for VIX options they purchased several (in the 1000’s) VIX Dec 17 Calls at 1.60 and sold the same number of VIX Dec 18 Calls at 1.25 and a net cost of 0.35. With the December future finishing the week at 19.60 and the spot index at 21.08 so far this trade is looking pretty smart.



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