Schaeffer's Trading Floor Blog

VIX Expiration: A Word of Warning

The games people play as VIX options expire

by 8/22/2013 7:31 AM
Stocks quoted in this article:

So what does VIX Expiration look like? Glad you asked.

Remember that expiring CBOE Volatility Index futures and options cash settle based on the opening price. But it's not really the opening price of VIX … rather, it's the calculated value of VIX based on the opening price of each qualifying SPX option.

How does an S&P 500 Index (SPX) option qualify? Either it has an opening trade, or the very next series further from the money has an opening trade. Once two consecutive series don't trade, the VIX calculator stops including further out-of-the-money series. If the September 1000 puts traded, for example, but neither the 1005 puts or 1010 puts traded, the implied volatility of the September 1000 puts would not be included in the VIX calculation.

Normally, you don't see all that many basically worthless SPX puts trade. On VIX expiration morning, though, that all changes. Here's how the SPX screen looked at midday (click to enlarge):

SPX options chain, August 21

The SPX was at 1,643 at the time. But some traders are pretty scared, apparently. At least 1,000 puts traded on every strike down to 1200, and then 11 or 12 traded on the strikes down to 1,150 (the strikes under 1200 traded after the open).

…OK, they're probably not really buying these puts. It's an exercise that takes place every expiration. It doesn't always impact VIX much. It may have had some impact this go around.

Incidentally, VIX had quite the gap on the open (click the chart to enlarge):

Intraday Chart of VIX since August 20
Chart courtesy of TD Ameritrade

Now to the naked eye, it looks like VIX opened at 16. And it would look that way to the trained eye also, as VIX literally did open at 16. August VIX, ostensibly based on the VIX open, settled at 16.42.

How's that possible?

Well, again, VIX settles based on where each qualified SPX series opens. So when the Chicago Board Options Exchange (CBOE) first calculated and disseminated VIX at 8:32 a.m. CT, I'm guessing many of those way out-of-the-money SPX series hadn't opened yet. Ergo, the disparity between the VIX open and the calculated VIX settlement price.

As you can see, VIX dipped initially, but ultimately rallied beyond the settlement price. It would have looked extremely absurd had VIX itself peaked on the open at 16, already a very large gap up, and VIX settlement been so significantly higher than that.

Keep in mind that the SPX didn't exactly implode on the open. It gapped down about four points. So the lift in the VIX itself was a bit out of line with the tame open, and the VIX settlement going significantly above and beyond that is just piling on.

My strong advice is to not hold onto any VIX futures or options into expiration. You're at the complete mercy of a very manipulated cash-out price. If you're on the right side, great. But it's a zero -sum game, so for every trader getting a windfall, there's another one getting money taken out of his account.

Disclaimer: The views represented on this blog are those of the individual author only, and do not necessarily represent the views of Schaeffer's Investment Research.


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