Thursday, March 31, 2011

VIN, VIF and an Obsolete VIX

Mark Sebastian at Option Pit has an interesting post up, Could the VIX Become Obsolete? that I suspect VIX and More readers will enjoy pondering. In it Mark argues that because of the VIX calculation methodology, SPX weeklys frequently offer a better insight into the state of current volatility than the VIX. Mark takes this analysis one step further by wondering aloud if this development could mean the demise of the VIX.

For those who are not familiar with the details of the VIX calculation methodology, the VIX bases its calculations on the front month and second month of the SPX for the majority of the expiration cycle. Eight days prior to the VIX options expiration, the SPX options used for the calculations roll forward one month to the second and third month.

Keeping in mind that the VIX blends SPX options with two different expiration dates to arrive at a constant maturity 30-day weighted average of SPX implied volatility, an example may help to illustrate what is happening. Next month the VIX options expire on Wednesday, April 20th. From today up to Monday, April 11th, the VIX is calculated based on the SPX front month (April) options as well as the second month (May) options. On April 11th, eight trading days prior to VIX options expiration, the SPX options used in the VIX calculations roll forward one month so that the near-term month used in the calculations is May and the far-term month used in the calculations is June.

Now, here is the fun part. It is a little known fact that the CBOE actually maintains separate indices for the near-term month VIX (VIN) and the far-term month VIX (VIF). Just pop those tickers into your streaming quotes and you too can watch not just the VIX, but the two components used in the VIX constant maturity blend. Right now, for instance, I show a VIX of 17.88, a VIN of 16.98 and a VIF or 18.23.  Just be sure to keep track of the SPX options series roll eight trading days before the VIX options expiration.

Of course the VIX really isn’t about to become obsolete. Just like any index, it suffers some limitations from being only one number. If you want a quick snapshot of where market volatility is, the VIX is the gold standard. If you want some more details and are one of those who likes to look under the hood and tweak the engine a little, the VIX futures and the SPX options themselves are probably the most important groups of market volatility data to study. For those who do not have easy access to VIX futures data, consider adding VIN and VIF to your watch list, to broaden your understanding of what is driving the level of the VIX.

Related posts (some excellent information in this group of posts and a particularly helpful graphic in XXV and the New VIX ETN Landscape):

Disclosure(s): none

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