Schaeffer's Trading Floor Blog

VIX-Piration Games

A postmortem look at VIX options expiration

by 7/17/2014 8:16 AM
Stocks quoted in this article:

Yesterday was CBOE Volatility Index (VIX) futures and options expiration -- always a fun time to watch the market opening.

For those new to the VIX games, the options and futures cash settle based on the initial quotes or trades in the qualified series on the S&P 500 Index (SPX) options board.

How does an SPX series qualify for this prestigious honor? It must be the proper expiration cycle (now August and September) and either have an opening transaction, or be closer to the money than a series that did have a transaction ... provided that there aren't two consecutive series without a transaction.

In English, if there's a trade in the August 1,700 puts, but then no trade in the August 1,695 or 1,690 puts, the VIX calculation will not consider any prices in series under 1,700.

The SPX is near 1,980, so surely we didn't see opening trades in series that far away, did we?

Guess what? We did see trades in series there, and way below there, as we magically see on every VIX expiration day.

Here's a slice of the SPX options screen from about 30 minutes into the trading day. The far-right column is the volume in each series, the column to the left of that is the pre-existing open interest (click chart to enlarge).

SPX options screen from July 16, 2014
Chart courtesy of TD Ameritrade

As you can see, every series traded down to the August 1,250 puts. That's an odd burst of demand for way out-of-the-money protection. Most series traded in volume far above the pre-existing open interest.

Of course, it had nothing to do with sentiment and everything to do with jigging the settlement price of VIX July contracts.

So how did that work out?

Well, here's VIX itself from about 3:30 p.m. ET on Tuesday through the overnight (when VIX is not calculated) into the early trade on Wednesday (click chart to enlarge).

VIX overnight chart from July 16, 2014
Chart courtesy of TD Ameritrade

Quite the gap down.

VIX doesn't settle at an actual VIX quote, it settles on a quote calculated off all those SPX options quotes. So it can actually settle at a price that VIX itself never sees. That's because the SPX options board does not all open at the same instant, especially when there are a bazillion series opening up on actual trades.

On the surface, it looks like VIX was knocked down for expiration. But oddly enough, it looks like it was jigged upwards a tad.

The market itself gapped up on the open, rose slightly more, and then dipped a bit. Here's SPDR S&P 500 ETF (SPY) (click chart to enlarge).

SPY chart from July 16, 2014
Chart courtesy of TD Ameritrade

VIX itself actually moved consistent with that. The first "print" was at 10.81, on the way down to as low as 10.59.

VIX futures and options, which ostensibly reflect the VIX open, settled at 11.02. VIX itself didn't print that high for 12 minutes.

So as odd as this sounds, the VIX settlement looks like it was artificially pushed higher, not lower. It's not readily apparent because the market action itself masked it. Had SPX simply flat-lined or gone higher after the open, VIX would likely have never printed as high as it settled.

Long story short, stay away from holding onto VIX options or futures that are about to expire. Don't risk the cashout; there's a good chance you'll have the wrong position on.

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


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