Don't trust the Greeks with Fear!

Update:  Chris McKhann commented on a recent post of mine, that  LIVEVOL provides free delayed quotes that include correctly computed greeks for VIX options. 



The broker quoted Greeks associated with VIX options are worse than a stopped watch. At least a stopped watch is correct once per day. The Greeks associated with the VIX options can only be counted on to be right once a month, the day you can't trade them--expiration day.

Computing the delta, gamma, and implied volatility of a option doesn't require much information, and most of it is common across whole families of options (days till expiration, cost of money, dividends) while one piece, strike price is static and specific to the option in question. The one remaining required piece of information in the price of the underlying--and our brokers thoughtfully provide us with the wrong number -- the VIX index value.

You can't buy or sell the VIX index, even if you have lots of money and brains. The best you can do so far is VIX futures--which settle once a month--based on the future value of the VIX index at one point in time. The rest of the time the VIX future wanders above and below the VIX index depending on how the futures market predicts the future, not current value of the VIX index.

The VIX option values track the VIX future value as the underlying not the VIX index. For example, if the VIX future value is higher then the index then deep in the money calls look outrageously expensive--with IVs on the bid side of several hundred. This suggests going short on the options while hedging with futures or VXX. On the other hand if the VIX future value is below the VIX index then IVs look very low. Any trading strategy based on these bogus numbers is asking for trouble.

You can compute reasonably accurate Greek values for VIX options yourself. You don't even have to get a futures quote (although you can get delayed quotes for free). It turns out that if you split the bid/ask price for the 10 strike VIX option and add 10 to it you can get close, usually within +-.15 to the true underlying price for the VIX options. You can then use freely available options calculators to compute your IV based on the underlying price and option price and then your Greeks. For example, today's ending prices:

True VIX Option Underlying (VOU) :

VOU = 10+ 14.55 (bid/asked split of VIX GB is 14.20/14.90) = 24.55

Closing price of 22.5 Call 1.85/2.2 (assume 2.10) for value

___________ VIX index __ VOU

Underlying ____ 24.40 ____ 24.55

Delta _________ .86 ______ .91

Gamma _______ .11 _______ .09

IV ___________ 143 ______ 82 (very close to the actual 20 day historic volatility)

Normally the VIX index and the VOU are further apart, so the Greek / IV differences are even larger, but there is only one more trading day for July options so the VIX index and VOU are converging.

So beware of broker quoted VIX option Greeks -- they are usually lying about the underlying.