As I type this, Congress is still debating the Troubled Asset Relief Plan (TARP) and various modifications and alternatives that have sprung up over the course of the past week.
While the outcome is uncertain, there is clearly a broad recognition that even a flawed plan announced before the markets close today may be better than the possibility of the panic and chaos we could see in global financial markets on Monday if Congress is still trying to agree on a course of action.
If there is no agreement on a bailout by the end of the day, VIX options might be one potential source of catastrophe insurance for your portfolio. Before I go any further, let me quickly add that VIX options are such a strange and difficult to understand animal that SPY or SPX puts is probably a simpler and better way for most investors to find catastrophe insurance on the S&P 500 index.
With that caveat out of the way, consider that the VIX now at about 36. It is important to understand that VIX options are not priced off of the cash/spot VIX currently at 36, but rather are priced off of VIX futures. This is an important distinction, as VIX futures for the month of October are in the 28s, the Novembers are trading in the 26s, and the December futures are trading in the 25s. For anyone looking to trade October VIX options, the underlying to focus on is October VIX futures, which is why the October VIX 20 calls are currently quoted at 8.80 – 9.10.
The second important factor to consider is that VIX futures move in a much more sluggish fashion than the cash/spot VIX index. For some supporting graphics to better illustrate how futures move vs. the VIX, try VIX Futures and Recent Market Action and VIX Futures: The One Picture to Remember. A rule of thumb is that VIX front month options generally move about half as quickly as the VIX.
If any of these thoughts about VIX options are new to you, then this is not the time to take a flier on VIX options. On the other hand, if you have an understanding on how these products work, it might be a good time to think about the VIX as portfolio insurance.