Looking for volatility exposure? Learn about volatility products including VIX options.
If history has taught us anything, it’s that you can expect market uncertainty. But many active traders say that a little volatility can actually be a good thing, especially if you’re prepared. So the next time a storm of volatility and uncertainty comes rolling into the markets, make sure you know your volatility strategies. You might just be able to catch a wave or two.
The following, like all of our strategy discussions, is strictly for educational purposes. It is not, and should not be considered, individualized advice or a recommendation.
It’s an obscure but raging debate: Should volatility be considered an asset class in its own right? No matter where you stand on the issue, some facts seem irrefutable:
So, is volatility an asset class? If you’re comfortable using volatility products to help you pursue your objectives, does it matter?
One point worth noting, however: VIX is a mean-reverting product. It doesn’t move in one direction over long periods of time, like the stock market has over the last decade. Typically, once fear subsides, VIX does return to a mean. This can be an important consideration when managing volatility trades and positions.
First things first: You can’t buy the VIX. Not directly, anyway. It’s a reference rate—an index made up of the implied volatilities of a basket of short-term options on the S&P 500 ($SPX), normalized to a 30-day constant maturity. But there are ways to sell and buy volatility exposure.
VIX Futures. One way to get volatility exposure is to consider VIX futures (/VX), which are simply the market’s anticipation of where the VIX will be at monthly points in the future (see figure 1). VIX futures are cash settled, with a final settlement value equal to $1,000 times the settlement price. So, for example, if you buy a VIX futures contract for 15 and it drops to 14, you’ll be down $1,000. The minimum tick size is 0.05, which represents $50. VIX futures settle to a settlement reference index under the ticker symbol VRO.
But futures aren’t for everyone. They involve leverage, and not all accounts allow the trading of futures. Plus, if you’re looking to buy and hold volatility, the value of your investment might erode over time. See the slope in figure 1? If you were to buy a futures contract a few months out and roll it to a deferred-month contract as it approaches expiration, assuming no changes to the term structure, you’d essentially be riding this curve downward.
That’s called “contango loss,” and here’s a hypothetical example. Suppose you bought a May contract with about three months until final settlement around the price of 18.1, as shown in figure 1. Note that, at the time of your purchase, the March contract (with about one month to go) is trading around 17.8. If the term structure remained the same over the next couple of months, two months later your May contract would go from having three months until final settlement to having one month to go. It would be priced (theoretically) around 17.8, where the one-month contract is trading now in figure 1.
FIGURE 1: RIDING THE VIX FUTURES CURVE. In typical markets, the term structure of VIX futures (/VX) slopes upward (called “contango”). Want to see today’s curve in the thinkorswim® platform from TD Ameritrade? Under the Charts tab, type in the symbol /VX and select Futures. Data source: Cboe Global Markets. For illustrative purposes only. Past performance does not guarantee future results.
Volatility ETFs and ETNs. If you’re looking for a buy-and-hold strategy and you either can’t trade futures or don’t wish to trade futures, there are a number of exchange-traded products such as volatility ETFs and ETNs that attempt to mirror the performance of the VIX. These products trade like stocks insofar as they can be bought and sold on exchanges and are generally available for most account types. They don’t hold securities, but rather use derivatives to attempt to track VIX performance. And although their aim is to mirror the VIX, they don’t always hit the mark. Because most of them use VIX futures, they’re subject to the same contango loss as VIX futures, plus a number of administrative and transaction costs. Many professionals refer to these ETPs as “watered-down vol exposure.”
VIX Options. If you’re looking for volatility flexibility and you have the appropriate level of options trading approval, you might consider VIX options. These are much like standard equity options, with a few key differences. First, they’re European-style options, which means they can be exercised only at expiration (as opposed to standard equity options, which may be exercised on any business day up to and including expiration day). Plus, unlike standard options that are physically settled into shares of the underlying stock, VIX options are cash settled (at $100 times the intrinsic value at expiration), with in-the-money options settling to the same settlement reference (ticker symbol VRO) as VIX futures. But perhaps the most important aspect of VIX options is that they’re based not on the VIX itself, but rather on VIX futures. (Learn more about the interplay among VIX, VIX options, VIX futures, and VVIX, which measures the volatility of VIX.)
If you’re a seasoned option trader, you’re likely familiar with the basic options strategies (and perhaps some not-so-basic options strategies). If you’re considering adding VIX options to your arsenal, be assured that most if not all of these strategies apply.
For example, are you anticipating a rise in market volatility? You might want to explore a bullish options strategy such as buying a call or perhaps a long vertical call spread. Or perhaps your objectives might be better served by a vertical credit spread—the sale of a near at-the-money option along with the purchase of a further out-of-the-money option of the same expiration date.
Uncertainty is a fact of life and the markets. So the next time the winds of uncertainty blow in a wave of volatility, perhaps you’ll consider hopping on and going for a ride.
Volatility ETPs are subject to significant risk and are intended for sophisticated investors who actively manage their investments daily. Volatility ETPs are intended for short-term trading, should not be used as buy and hold investments, and should not be expected to appreciate over extended time periods.
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, leverage risk, credit risk and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
Leveraged and inverse ETFs entail unique risks, including but not limited to: use of leverage; aggressive and complex investment techniques; and use of derivatives. Leveraged ETFs seek to deliver multiples of the performance of a benchmark. Inverse ETFs seek to deliver the opposite of the performance of a benchmark. Both seek results over periods as short as a single day. Results of both strategies can be affected substantially by compounding. Returns over longer periods will likely differ in amount and even direction from the target return for the same period. These products require active monitoring and management, as frequently as daily. They are not suitable for all investors.
Investors cannot directly invest in an index.
Futures trading is speculative, and is not suitable for all investors. Please read the Risk Disclosure for Futures and Options prior to trading futures products. Futures trading services provided by TD Ameritrade Futures & Forex LLC. Trading privileges subject to review and approval. Not all clients will qualify.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.