Schaeffer's Trading Floor Blog

The Newest Volatility Vehicle on the Block

CBOE will begin trading VXST options today

by 4/10/2014 7:33 AM
Stocks quoted in this article:

As of tomorrow, our long national nightmare will be over! We can trade options on the CBOE Short-Term Volatility Index (VXST)!

Okay, it's not that long a nightmare. The data is calculated back to January 2011, but the Chicago Board Options Exchange (CBOE) just rolled out "live" VXST half a year ago. Just to refresh on VXST.

The VXST Index is based on real-time prices of options on the S&P 500 Index that expire every week, and is designed to reflect investors' consensus of future (nine-day) expected stock market volatility. The time series data history for the index begins in January 2011, and the VXST experienced sharp rises of more than 40% on nine different trading days since January 2011.

Options will expire every week on Wednesday, which makes sense on a short-term product. Just like VIX options, they cash settle.

Generally when someone markets a new trading product, they highlight decreased volatility as a feature. Well, not so much in VXST.

Here is a list of the 360-day historic volatility for securities and futures as calculated by Bloomberg on April 8. High "vol of vol" plus negative correlation can make for a very intriguing investment instrument. The historic volatility of the VXST (and of short-term expected volatility) was much higher than that of the CBOE Volatility Index (VIX), the CBOE S&P 500 3-Month Volatility Index (VXV), the CBOE Mid-Term Volatility Index (VXMT), and other volatility indexes.
360-Day Historical Volatility as of April 8

Time will tell whether this product catches on. But, I like the concept here better than VIX options and futures. Everyone wants to bet on "spot" VIX. Even though this isn't actually VIX, it will capture blips in VIX way better than actual VIX-labeled derivatives. Let's face it, betting on where VIX will close on some date one month or three months or six months from now is a de facto coin flip. If you think VIX will lift over time … well, join the club, the market virtually always prices in a VIX pop out in time as we've noted again and again. All you're really betting on is the magnitude of the "inevitable" future VIX pop. And it's more often than not a bad bet. If you're using it as some form of portfolio hedging, well … that hasn't worked too well either.

Contrast that with playing implied volatility with VXST options. It's a bet on a volatility move in the here and now, which is really where we should focus our plays anyway. Volatility of volatility works both ways of course. You can choose … poorly … of course. But, that's why options work particularly well on a product like VXST. You can only lose your total cash outlay on the options, and since they all expire soon, you're not going to pay huge money in dollar terms.

On the flip side, you will pay up in implied volatility terms. And if you keep "betting" every week, those losses could add up before you hit that big winner. It clearly lends itself to making sporadic short-term plays on your volatility opinions, which in my humble opinion is exactly how you should use a tradable volatility product anyway. It won't work well as a longer-term portfolio hedge, but I'm not sold that VIX futures and options accomplish that goal too well, anyway.

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


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