Schaeffer's Trading Floor Blog

Coming Soon: Weekly Volatility Bets

The CBOE prepares for weekly expirations on the VXST

by 2/12/2014 7:10 AM
Stocks quoted in this article:

While we were sleeping and/or watching the recent VIX Pop and Drop, there were some developments in the tradable volatility front.

We've outsourced our Contango Technology to India!

Futures contracts on India VIX index will start trading on February 26, the NSE said in a circular on Friday.

India VIX is a volatility index based on the index options prices of the Nifty.

VIX futures will consist of weekly contracts, with expiry every Tuesday of the week.

Who needs monthly expiration when you can have a weekly expiration? Why can't we get that over here?

Oh wait … we're about to.

CBOE Futures Exchange, LLC (CFE) announced today that it plans to launch trading of futures with weekly expirations on the new CBOE Short-Term Volatility Index (ticker symbol: VXST) on Thursday, February 13, pending regulatory review.

Chicago Board Options Exchange (CBOE®) developed the CBOE Short-Term Volatility Index ("VXST Index" or "Short-Term VIX Index") in response to proven demand for Weeklys options generally, and volatility contracts that measure a shorter time period in particular. Like CBOE's flagship CBOE Volatility Index® (VIX Index), the Short-Term VIX Index reflects investors' consensus view of expected stock market volatility using CBOE's proprietary VIX methodology. Both indexes use S&P 500® Index (SPX) options in their calculations. The VIX Index uses SPX monthly options to measure expectations of 30-day volatility, while the VXST Index uses SPX options that expire every week (including SPX Weeklys) to gauge expectations of nine-day volatility. The VXST Index's shorter time horizon makes it particularly responsive to short-term volatility triggered by market events such as corporate earnings, government reports and Fed announcements.

I poke fun of and/or warn about all the countless volatility derivatives that come our way. But these VXST futures do certainly fill an untapped area on the trading curve. As we note often, VIX futures always price in mean reversion. When the CBOE Volatility Index (VIX) pops, suddenly -- as it did in the last couple weeks -- VIX futures correctly lag the move. That's because they simply snapshot where the market sees VIX on some date in the future. If it's 30 days or more away, the market will generally assume the lift in VIX will have dissipated by then. If it's a very near-term future, it will lift much closer to the lift in VIX itself. But it expires soon and it's cash settled, so unfortunately you only get the play on for the short term. For example, you can "lock in" selling VIX at a high price, but you may only have a few days or a week of play on it, at which point it closes out at the VIX settlement price and you simply get cashed out.

These new VXST futures will have the same dynamic. They'll move with VXST itself … and as you may have noticed recently, VXST can really move around. The problem is, you're going to have a relatively short window of play on them. You will have four cycles to play with at any given time, but keep in mind the curve is going to act like a compressed version of the VIX term structure. That is, the four-week futures won't pop as much as the three-week futures, which won't pop as much as the two-week futures. So you're really going to have to time trades well.

Take hypothetical VXST futures on this last volatility move. The volatility rally lingered for about eight-nine trading days. Let's say you wanted to sell VXST futures right after the initial pop. You would have gotten the highest price on the nearest-term future … and that would have turned into the single worst play, as volatility did not drop until after that future expired. You would have gotten the worst prices on VXST futures with around three and four weeks remaining, yet those likely turned into nice winners.

And that's a lesson you can probably generalize for any volatility in question. If you want to fade a volatility rally, go for "time" over the seemingly better prices earlier in the curve.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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