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Minyan Mailbag: Volatility Anomaly



Editor's Note: Minyanville is a community of people who share an interest in fiscal literacy. As perspective is an important aspect of our daily routine, we share this email with hopes that it adds balance to your process.

Prof. Succo,

I watch the VIX and the VXO pretty much every day. I notice the spread between them widen and then shrink over and over and over again. There is now about a 10% difference between the two. The VIX is 11.05 the VXO is 9.96. What is it about 100 stocks that would have less volatility than 500 stocks? Is it just a function of bigger names, or is it the composition sector weighting that is different, or both?

Would you expect one to be more volatile than the other looking ahead, and if so given there are no VXO futures, how would one take advantage? Do you see any theoretical plays in this regard?

I do have questions on VIX futures as well. The August VIX future is 124.00 by 124.70 (bid ask). The October VIX future is 140.60 by 141.90. Meanwhile I see the VIX is at 11.00 on the nose (110.00 if by my assumption it needs to be multiplied by 10).

Why would the VIX Future for August be 124 if the VIX is at 110? When do VIX futures expire anyway, as I am having a terrible time getting any information on these. I guess it would make sense they expire right along with S&P options (third Friday of the month at the open) but that is a guess. At expiration (assuming we expired in a week with nothing changing) would those futures trend towards 110 and then expire there?

I guess I am trying to figure out the difference between 110 and 124 and why it is so great. Do you even consider that to be a big spread? The contango is even worse looking at October. Does the combination of factors make it hard to trade these things? Certainly the Contango would make buying calls a very tough proposition IMO, unless things got really ugly.

If one was inclined to play this as a long term position would it seem better to play the front months and roll them over or go further out and pony up? My instinct is for the former given the contango and the fact that we just may (someday) get a huge spike in volatility in the leading contract.

If there are any other issues that you can think of that I did not ask, I would appreciate comments as you think of them. As I said, I am having a terrible time getting information about the VIX futures so your help in understanding this would be greatly appreciated.

Minyan Mish


The CBOE uses different methodologies to calculate the VIX and VXO - it is not the same calculation with a simple change of SPX for OEX. One of the differences is in which options are used in the calculation. The VIX (SPX) always uses a fixed 30 days to expiration and weights near term and next term options accordingly. The VXO (OEX) uses equally near and next, and once per month rolls them. This will cause a gradual shrinking followed by a spike in the spread between the two in a rising term structure environment (options out the next month have a higher implied volatility than the near month options).

For this reason, the VXO will always be more volatile than the VIX unless the term structure is flat. I don't believe there is a trade to take advantage of this anomaly.

The VIX calculation is currently weighting August SPX options much more heavily than September SPX options. As times passes, September will garner an increasing weight and on August expiration the September month options will be nearly all the weighting. Since September volatility is 1 ½ to 2 points higher than August volatility, the August VIX futures will trade at a premium to spot although it is in line with the contract underlying.

The last trading day for VIX futures is the Tuesday prior to option expiration and the settlement price is determined the next open (Wednesday).

Prof. Succo

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