VIX Expiration: 'Strategy' Orders and HOSS

VIX expiration may be confusing, but it's also highly transparent

by Adam Warner

Published on Nov 24, 2015 at 10:16 AM
Updated on Jun 24, 2020 at 10:16 AM

CBOE Volatility Index (VIX) expiration morning is an interesting time for options trading -- that is, if you find an inordinate quantity of out-of-the-money (OOTM) put orders "interesting." Here's the deal. Lots of OOTM puts in the S&P 500 Index (SPX) trade on every VIX expiration. VIX futures and options cash settle based on the opening quotes on the SPX board the day of VIX expiration. Here's a rundown of the series that went into the VIX November expiration: 132,916 December puts traded from the 1,750 strike down to the 975 strike.

I erroneously thought that all strikes qualified for the settlement, but it "only" went down to 975. I eyeballed the board and didn't notice two consecutive strikes not trading down there. My bad.  

Anyway, is that a bit high for an open? Well, I'm looking at the board mid-session on Monday and maybe 3,000 have traded -- and over half in one series (December 1,475s). So, clearly, something happens on VIX expiration. It's not rocket science to connect a volume surge in mostly far OOTM series to the fact the prices of these series matter, insofar as the value of the VIX contracts are concerned.

The CBOE is well aware of this and does take many steps to regulate and shine light on the process. It's described here.

All "strategy" orders (more on that in a sec) must be submitted to what they call their Hybrid Operating System, or HOSS (not to be confused with Giants Super Bowl XXV hero Jeff Hostetler, also called "Hoss"). Orders must be in by 8:15 a.m. CT and then can't be modified from that point on until after the open. HOSS disseminates public info about imbalances here.  

Thus, all the info is publicly available. If you have an expiring VIX position, you can know or infer what's likely to happen to it on the SPX open. What you can't do is modify that position, as the expiring VIX products do not trade on the Wednesday open -- they just cash out.  

What's a "strategy" order you ask? The CBOE defines it as follows:

"In general, CBOE shall consider option orders to be related to positions in, or a trading strategy involving, volatility index options or futures for purposes of CBOE Rules 6.2B.01 and 6.2B.08 if the orders possess the following three characteristics:

"1) The orders are for option series with the expiration that will be used to calculate the exercise settlement or final settlement value of the applicable volatility index contract. For example, in the case of VIX futures, the orders would be in standard SPX option series that expire one month following the expiration date of the expiring VIX futures contract.

"2) The orders are for option series spanning the full range of strike prices in the appropriate expiration for option series that will be used to calculate the exercise or final settlement value of the applicable volatility contract, but not necessarily every available strike price.

"3) The orders are for put options with strike prices less than the 'at-the-money' strike price and for call options with strike prices greater than the 'at-the-money' strike price. The orders may also be for put and call options with 'at-the-money' strike prices.  

"Whether option orders are related to positions in, or a trading strategy involving, volatility index options or futures for purposes of CBOE Rules 6.2B.01 and 6.2B.08 depends upon the specific facts and circumstances. Other types of orders may also be deemed by CBOE to fall within this category of orders if CBOE determines that to be the case based upon the applicable facts and circumstances."

Long story short (probably too late for that already), traders essentially create "strips" that replicate the VIX settlement. I presume it's offset by the cash out in the actual VIX paper. The whole process is very transparent.

The vast majority of players not on this side of the trade only have exposure to this whole process if they have expiring VIX positions -- it does not affect non-expiring VIX positions. If you choose to leave a near-the-money VIX option open into VIX expiration, you run the risk of an unfavorable run-off. You also might benefit from the run-off. Just know that's what you're gaming and decide whether that's a game you want to play.

Take last expiration for example. November 19 calls seemed likely to expire worthless. VIX itself closed and then opened below 19. Yet VIX settled above 19 on the SPX put fiesta. If you owned the calls, great, you cashed out at 17 cents per contract. If you were short the calls, that's 17 cents given away.

There's nothing particularly nefarious about the whole shebang. It's just worth learning about if you ever intend to leave positions on.

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

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