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Trading VIX Options? Good Luck To You!

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You aren't betting on where volatility will be in June, you're betting on how traders think future volatility will be priced in June.

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There were 2 articles out recently about the structure of volatility derivatives. One suggested the worst was probably over; the other suggested investors bet on a return to volatility.

The note out today from BNP Paribas suggested that investors buy call spreads on the VIX, which would profit if implied volatility made a strong comeback by mid-June. If the VIX closed above 55 at expiration, then the options trader could pocket up 12.5 points per trade. If it closed below 42.5, then...well, your position would probably be about as useful as a third nipple.

The problem with these trades is that derivatives on the VIX don't always move as planned. Check out Adam Warner's blog, he's been all over this topic.

The following chart shows the May VIX futures contract versus the cash VIX index that we're all used to. As we can see, they don't always move in tandom.



The CBOE site itself suggests that VIX options traders look at VIX futures instead of the cash VIX index to get a better handle on how their options may fare. Remember, you're not necessarily betting on where volatility will be in June, you're betting on how traders think future volatility will be priced in June.

Buyer (or seller) beware.

Source:

Morgan Stanley Says Risk of 'Sizable' Equity Moves Now Lower
Bloomberg, April 22, 2009

VIX Set to Increase on 'Fading Excitement,' BNP Paribas Says
Bloomberg, April 24, 2009



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