Lowest VIX Close Since Day Before Biggest VIX Spike Ever

I’m generally not one for sensationalist headlines, fear-mongering or otherwise stirring up trouble unnecessarily, but when facts line up in a manner that I know others will find interesting, I do feel an obligation to point that out.

So…at the risk of being splashed all over the Zero Hedge comments stream I thought it worth noting that today the VIX closed at 11.56. While this marks the lowest close in the VIX in over six years, a surprising portion of this low VIX is the result of a calculation quirk I described earlier today in The VIX, Interpolation and the Roll. In other words, I would characterize today’s VIX as artificially low and considerably lower than the near-term VIX calculation (VIN).

That being said, there is no denying that the last time the VIX closed below today’s close was February 26, 2007, the day before The Biggest VIX Spike Ever, a 64% jump in one day.

Do I expect a new record VIX spike tomorrow? Hardly, though I should note that just two weeks ago today we did see the #11 all-time VIX spike for a single day.

What is more likely to happen is that the negative coefficient for the weighting of the far-term VIX calculation (VIF) will slowly dissipate over the course of the week and that in itself should lift the VIX about three-quarters of a point. Throw in a just one or two days of declining stocks triggering the purchase of SPX puts for portfolio protection and it would be very easy to see the VIX up more than 20% from its current level by the end of the week.

Looking back at the concerns that dominated my fear poll a couple of months ago, most of these have dramatically receded. For this reason, it looks like it will take one of those unexpected threats to get the VIX airborne once again.

Related posts:

• The Biggest VIX Spike Ever: A Retrospective
• All-Time VIX Spike #11 (and a treasure trove of VIX spike data)
• The VIX, Interpolation and the Roll
• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX
• Investor Fears Pivot to U.S. Deficit and Debt Ceiling Following Cliff Deal

Disclosure(s): none

The VIX, Interpolation and the Roll

Almost every month, some subset of the class of investors and journalists expresses extreme alarm when the VIX magically plummets on the Monday before the standard monthly options expiration that occurs on the third Friday of every month.

I have written about this before, notably in:

• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX

The executive summary is that for most of its monthly cycle the VIX is an interpolated value derived from the first and second month S&P 500 index (SPX) options contracts. In an interpolation, one is presented with two values and attempts to derive a value that is in between those two, typically by drawing a straight line between the values and attempting to determine where on that line the desired value should fall. When one wants to derive a 30-day VIX and the SPX options contracts are, say, 17 and 45 days out, then a simple linear interpolation accomplishes that goal – and that is what the VIX calculation methodology does.

Things become more interesting due to the fact that the CBOE mandates that the near-term month used in the VIX calculation have at least one week to expiration. So what happens is that on Friday the VIX used the March and April expirations in the VIX calculation; today April becomes the near-term month and May becomes the far-term month. With the April expiration falling on April 19^th and the May expiration on May 17^th, this means the two months used in the VIX calculation have 39 and 67 days until expiration, respectively. So how does the CBOE arrive at a 30-day VIX value? Well, they still use the near-term VIX calculation (VIN) and far-term VIX calculation (VIF), but they accomplish this task by using a negative coefficient for the weighting of the far-term value, in addition to a coefficient that is greater than 100% for the near-term value.

There is nothing wrong with this approach and it delivers reasonable numbers when the near-term and far-term VIX have roughly the same value, but when there is steep contango in the SPX options term structure, which has frequently been the case over the course of the past two years, the resulting VIX calculation can be dramatically lower than both VIN and VIF. Right now, for instance, the VIX is at 11.71, while VIN is 12.48 and VIF is 13.50.

My suggestion would be not to focus too much attention on the VIX while the calculation uses a negative coefficient for VIF, which will be for the remainder of this week. Instead, those looking for a better gauge of what the VIX is should probably focus on VIN for the next four days.

Alternatively, one can refer to SPX implied volatility calculations provided by their options data provider, such as are incorporated into the SPX skew graphic below, courtesy of LivevolPro.

Related posts:

• How Can the VIX Be 14 and Lower than VIN and VIF?
• VIN, VIF and an Obsolete VIX

[source(s): LivevolPro.com]

Disclosure(s): Livevol and the CBOE are advertisers on VIX and More

How Can the VIX Be 14 and Lower than VIN and VIF?

Many novice and advanced VIX followers are scratching their heads today, wondering why the VIX is down more than 5%, hovering around the 14.00 level, when the SPX is down 0.4% and all the major market averages are deeply in the red. More serious students of the VIX will also note that this drop in the VIX comes on a Monday, when the typical VIX “calendar reversion” is generally responsible for about a 1% pop in the volatility index.

The answer to most of these questions lies in yet another idiosyncrasy of the VIX: the roll. Quoting directly from the source, the CBOE Volatility Index (VIX) White Paper, we find these two important nuggets from pages 4 and 9, which I have presented here sequentially for easier consumption:

“The components of VIX are near- and next-term put and call options, usually in the first and second SPX contract months. ‘Near-term options must have at least one week to expiration; a requirement intended to minimize pricing anomalies that might occur close to expiration. When the near-term options have less than a week to expiration, VIX ‘rolls’ to the second and third SPX contract months. For example, on the second Friday in June, VIX would be calculated using SPX options expiring in June and July. On the following Monday, July would replace June as the ‘near-term’ and August would replace July as the ‘next-term.’”

“At the time of the VIX ‘roll,’ both the near-term and next-term options have more than 30 days to expiration. The same formula is used to calculate the 30-day weighted average, but the result is an extrapolation of σ² 1 and σ² 2; i.e., the sum of the weights is still 1, but the near-term weight is greater than 1 and the next-term weight is negative (e.g., 1.25 and – 0.25).” [Emphasis added]

When I first posted about VIN and VIF back in March 2011 (VIN, VIF and an Obsolete VIX), I was stunned to learn how few investors, including savvy and experienced VIX fanatics, were completely unaware of these indices. At the time, the CBOE did not even refer to VIN and VIF on their web site, but they have since added a splash page for these two indices, along with the following brief comments:

CBOE maintains indexes that track the level of implied volatility from single SPX maturities.

Ticker VIN (VINX on Bloomberg) – nearer term SPX expiration used in VIX calculation

Ticker VIF – farther term SPX expiration used in VIX calculation

Getting back to the roll, the SPX options contract months roll forward one month today, so that the nearer-term month (VIN) moves from August to September and the farther-term month (VIF) moves from September to October. More importantly, per the bolded text from the VIX white paper above, today’s VIX calculations sum more than 100% of the VIN and a negative number for VIF. This is the reason why the VIX is less than the two components used in its calculation: VIN and VIF.  In summary, the bigger the difference between the VIN and the VIF (and right now that difference is a very large 9.4%), the more likely the VIX is going to be substantially depressed following the VIX roll.  Also, as we move toward the expiration of VIX options on August 22nd, the distortions from the negative VIF component used in the VIX calculations should gradually diminish, as the VIF weighting moves toward zero and then becomes a positive number.

For those who are interested in delving into the nuances of the VIX calculations, the CBOE’s VIX White Paper is the best place to start; the links below might also provide additional insight.

Related posts:

• VIN, VIF and an Obsolete VIX
• The Calendar Effect and Time Decay
• Rule of 16 and VIX of 40
• Ten Things Everyone Should Know About the VIX

Disclosure(s): long VIX at time of writing

The Convergence of VIX and VIX Futures at Expiration

VIX futures and options expire 30 days prior to the expiration of options in the S&P 500 index for the following month. With the September SPX options expiration set for September 16^th, this means that August VIX options will expire on next Wednesday, August 17^th.

Students of the VIX (and there seem to be many when the VIX spikes over 40) should all know that over the course of their life, VIX options are not priced off of the VIX index. Instead, the best approximations for the appropriate underlying for VIX options are the corresponding VIX futures. The one caveat is that at expiration, the VIX index and VIX futures must converge on a single price for the VIX. This price convergence in the VIX and VIX front month futures is always interesting to watch, but particularly so in high volatility environments.

The mechanics of the VIX settlement process are non-trivial, but suffice it to say that they settle with a Special Opening Quotation (SOQ) at Wednesday’s open, based upon opening trades (as well as the midpoint between the bid and ask) in SPX options. As a result, the last opportunity to trade VIX August futures and options is the session before the SOQ, at Tuesday’s close.

With two full trading days plus 1 ½ hours of today’s session left, there is a substantial discrepancy between the VIX and the VIX futures. As I type this, the VIX is at 36.40 and the August VIX futures are at 34.50. Somehow that gap needs to be closed in the next two days. Right now the market’s best guess is that the VIX will fall 1.90 points by Wednesday’s SOQ, but of course the final settlement could be between the two current values and quite possible above 36.40 or below 34.50. If you are trading any of these instruments, you should be aware of the price gap and the path of the convergence. You might also use this opportunity to brush up on the little-known near-term month VIX index (VIN) by checking out VIN, VIF and an Obsolete VIX.

Related posts:

• VIN, VIF and an Obsolete VIX
• Ten Things Everyone Should Know About the VIX
• Rule of 16 and VIX of 40

Disclosure(s): Short VIX at time of writing

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 20^th. From today up to Monday, April 11^th, the VIX is calculated based on the SPX front month (April) options as well as the second month (May) options. On April 11^th, 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):

• Ten Things Everyone Should Know About the VIX
• Rule of 16 and VIX of 40
• XXV and the New VIX ETN Landscape
• VIX and VXX: In the Beginning…
• VXX Calculations, VIX Futures and Time Decay
• VIX Futures: What Were/Are They Thinking?
• Overview of U.S. Volatility Indices

Disclosure(s): none