A period of historically low volatility has made VIX options particularly popular
In recent months, we've spent a lot of time discussing the current period of historically low volatility, and what it means for stocks in the short- and long-term. Needless to say, the ongoing lull in volatility has made many traders nervous about an upcoming spike, leading to an unusual level of interest in the CBOE Volatility Index (VIX). Often dubbed the stock market's "fear index," the VIX is a statistic that measures volatility expectations for the S&P 500 Index (SPX), but it has no shares that can be bought or sold. Therefore, investors looking to make a play on volatility are left with a few choices: VIX futures, exchange-traded notes (ETNs) such as the iPath S&P 500 VIX Short-Term Futures ETN (VXX), or VIX options.
One of the notable events on this week's calendar was the expiration of VIX options, which occurred at the market close on Wednesday. As Schaeffer's Senior V.P. of Research Todd Salamone noted in this week's Monday Morning Outlook, VIX options expiration can lead to an increased short-term risk of a volatility spike, as now-unhedged traders could panic in response to negative headlines. As such, we'll narrow in on these peculiar options, how they're traded, and how they can affect the broader market.
VIX options differ from regular stock options in a couple of ways. For one thing, VIX options are not based on the underlying spot price. Instead -- and rather like futures -- they're based on the expected price at expiration. For example, the most active VIX option today is the April 18 call. While the VIX hasn't seen a reading as high as 18 since November, buyers of the call are betting the market's "fear gauge" will spike to this level by the option's expiration, on Wednesday, April 19.
That, of course, bring us to the second major difference. VIX options do not expire on the third Friday on each month, along with regular stock options. Instead, they expire on the Wednesday that's 30 days prior to the third Friday of the next calendar month -- which may or may not fall in the same week as regular options expiration.
So why are VIX options so hot right now? For one thing, an uncommonly long period of muted moves for the volatility indicator has some traders betting on a breakout. And with traders nervous about a stock correction in the wake of the "Trump rally," a play on VIX is a good way to bet on a big move for stocks. Moreover, VIX options can also be used to hedge positions on VIX futures, as well as long stock portfolios.
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