Tuesday, November 03, 2009

Confusion about the VIX and VXX continues

It is possible that the confusion about VIX, VIX options, and the VXX will be permanent.  This article is typical.

One quote: "The recent market action has pushed the 30-day historical volatility up to 20 percent, but clearly the VIX continues to price in far more volatility than there actually is."

People seem to want the VIX index to reliably track the historic volatility.  While this is an interesting comparison, the VIX is tied to current (minute by minute) SPX options premiums.  Do people really think that options traders give a rip about historical volatility?   The premium (usually expressed as implied volatility) of these options is about supply and demand together with fear and greed.    On a fearful day like today people are willing to pay a premium for protective puts--hence the VIX goes up.  The maximum volume on a specific strike was more than 2X for puts (23000 at a strike of 1000) compared to calls (8465 at a strike of 1050).   The VIX index is not a market, you can't buy or sell the index--it is a metric! Like the temperature gauge on your car it just measures something.

Another quote: "But when the VIX is above the VIX futures, as it is now, then the VXX becomes a great way to play a further pop in volatility. The VXX is based on the futures trading at 28, and the VIX is above 30. The futures are pricing in a lower VIX, but if the VIX continues to climb, the VXX will actually outperform."

Huh?   Outperform what?  When the VIX index is strongly up VXX  and VIX options will always be below the VIX,  because they are based on VIX futures--which inherently lag compared to the computed, realtime VIX index.   The VXX, being a mix of the nearest, plus the month out futures has no real potential to out "pop" the VIX options, which themselves will always be out popped by the VIX index itself.   As far as I can see the only advantages the VXX has is that it is not a confusing thing like a future, or an option, and you can actually buy it.

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