A Perplexing VIX Theoretical

If the CBOE Volatility Index (VIX) happened to be delayed on the same day VIX futures expire ... things could get interesting

by Adam Warner

Published on Sep 2, 2015 at 8:40 AM
Updated on Sep 3, 2015 at 8:13 AM

About that CBOE Volatility Index (VIX) shutdown last week: In one sense, it's of course meaningless. I mean, you really don't need the VIX up there at all times to tell you volatility is exploding. But in another sense, it could lead to some serious problems. Here's an interesting hypothetical from Eli Mintz of VIX Central:



Well, on one hand, it wouldn't matter at all. VIX futures and options cash settle, but it's not based on an actual VIX quote. Rather, it's a calculated VIX based on the implied volatility of all the qualified S&P 500 Index (SPX) options series. Theoretically, VIX derivatives can settle at a price that VIX itself never sees. In fact, that's not theoretical, it has happened multiple times. That's because all SPX series do not open at the exact same instant. Perhaps SPX moves a bit, or volatility itself moves a bit around an open. Say we gap one way and make a quick reversal, it's not that uncommon.

But on the other hand, delayed VIX could be a total disaster on VIX-piration day. That's because the VIX is probably delayed because some SPX series haven't opened yet. Think of actual Aug. 24. SPX probably had a 50-point range before all SPX series even opened. Maybe it was 100, I'm not sure at what point everything caught up. The implied volatilities on opening quotes were likely all over the map.

What happens if you have a pre-existing position?

Again, you get cashed out. But remember VIX that day? VIX itself opened at 53, up about 25 points. But by the time that "quote" came out, the market had recovered off the lows. So perhaps the "real" VIX settlement (symbol VRO, actually) was even higher. Or lower. And we're not talking pennies, we're talking dollars, maybe $5, maybe $10, who knows.

And here's the real scary part: 99.9% of us literally can't hedge them at all. Trading in VIX options and futures stops on the close before they expire, so anyone with a pre-existing position is at the mercy of the next day's open. It's a lottery to begin with, though one that is usually not an enormous deal. Every VIX expiration, all sorts of way-out-of-the-money put series magically trade and the strikes get included in the VRO. The net effect on VRO is not all that large. In a volatility explosion, though, the dollars involved would be huge and the lottery is now an exponential lottery. And again, it's almost a random settlement price if series are opening 10-20-30 minutes apart.

What's the solution if this ever happens on VIX-piration day? I have no idea. I'm hoping there's some sort of contingency plan out there because anyone and everyone on the wrong side of a settlement thrown off by technical glitches has a serious case for some reimbursement.

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


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