It's Monday, it's late summer, it's a range-bound market. How about we have a little fun with Selective Endpoint Theater: VIX Edition! 

CBOE Volatility Index (VIX) is now in the high 12s, which of course seems very low in this world of Yuan Devaluations, Fed Hikes?, et. al. But for the umpteenth time, it's really not low vs. realized volatility (RV), as 10-day RV sits in the mid-9s.

Yes, that may mislead a bit, as it fails to capture the full effect of big reversal days like we saw on Wednesday. But there's no real way to tweak it to make it much higher, as most days really do have low ranges. Market Not Rallying doesn't equal Market Volatile.

Besides, the relative perception of VIX does depend a bit on your time frame. Looking at 2015 as a whole, yeah, it seems quite low.

 

If we started paying attention in late June, it really looks like a vol crash.

What's with the massive complacency? Well, to the guy that just showed up a month ago, the answer is probably "what complacency?"

We're right at the midpoint of the range! My point isn't really that VIX is fat or fair or cheap, more that it's pretty much all of the above -- or at least two of the above; no one's saying it's "fat" here.

It's important to keep the calendar in mind. We're back to one of those sleepy times of year. "Regular" August options expiration is this Friday, followed by the dreaded two weeks into the holiday. Of course, we had that in late June and that's precisely when we saw a big VIX spike. If anything, it makes more sense to see one now. September is a generally busy month and of course we have Fed Hikes? on tap. Guessing there's about 15,000 financial TV features about it between now and then. 

So, don't go to sleep on VIX just yet. (As if anyone needed a reminder of that!) 

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

Just when you thought the waters were safe, China strikes again. Shocking, I know. 

As Matt Moran of the Chicago Board Options Exchange (CBOE) notes, implied volatility (IV) on the iShares FTSE/Xinhua China 25 Index ETF (FXI) has exploded (again) this week. We're certainly higher than the norm, but still a bit away from spike levels of a July.

Ten-day realized volatility (RV) in FXI is about 24 now, so mid-30s IV seems pretty reasonable, given the action over there. RV reached a high of 64 back on July 10, and remained super elevated for about a week before gradually dipping back into the teens. We're clearly way off the panic levels from back then.

An optimist could say, "That's a good sign, as we're starting to discount the China market implosion a bit." A pessimist could say, "OMG, what if the vol gets back up to July levels? Sell everything! Ask questions later."

For 99.9% of us, it's more important how this all impacts our markets. We didn't rally exponentially with China back in the spring. Rather, we were busy worrying if Greece was going to blow up the eurozone and tank the world economy. Now we've turned the channel to the China Network.

It's kind of instructive to see how the CBOE Volatility Index (VIX) looks vs. FXI vol:

Before April, the vol indices moved in lockstep. Then China vol spiked and we pretty much ignored until June. At that point, FXI really spiked, and we started following it pretty much tick for tick. And we are still following. Here's how that same chart looks when I start it three months ago:

Yes, our options literally move tick for tick now with FXI options. 

This won't all end with China settling down. It's just not happening overnight -- I mean, they might rally overnight, but it's likely their shakeout persists. It's only going to end here when we decide Chinese economic contraction is discounted here. 

We could, theoretically, then rally … But who am I kidding? In 2015, all that means is that we started obsessing over some other burgeoning economic disaster. 

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

We're kind of at a crossroads here, stuck between Fear and Bigger Fear! Put options are the new "in" thing to own, as we noted on SchaeffersResearch.com last week:

"… [T]he average 10-day buy-to-open put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) sits at 0.73 -- the loftiest level since June 5, 2012, when the S&P 500 Index (SPX) was trading near 1,285. In other words, option traders are placing bearish bets at a much faster-than-usual clip, buying to open puts over calls." 

OK, maybe more like calls are out of vogue, as call volume has dropped 36% year-to-date. And this was before the Thursday implosion. 

That's single stock calls. CBOE Volatility Index (VIX) calls are as popular as ever, per the OptionMONSTER VIX Sonar Report. Again, that's before Thursday. 

Investors? Tough to find a bull these days. According to the American Association of Individual Investors (AAII) sentiment survey, the number of self-identified bulls last week fell 3.6 percentage points to 26.8%.

In all fairness, though, they're not becoming bears (yet), but rather neutral observers. The number of bears dropped 2.8 percentage points to 33.3%, and the number of neutral investors surged 6.4 percentage points to 39.8%. Guessing that will change big time by the next reading.

And then, of course, there's the CNN Fear and Greed Index:

Every component is in Extreme Fear. (Not sure why the index isn't more like "2," so maybe there's an "Even Extremer Fear" setting or something.) 

Oh, and VIX is well overbought too. More on that Monday.

Let me also throw in that the SPDR S&P 500 ETF (SPY) is now well below its 200-day moving average. That's not wildly bearish, per se, but a good simple indicator to stay on the sidelines. 

Yada yada yada, we're pretty oversold and over-bearish here. Most of the time that's a good contra tell. On the other hand, we crash off oversold. If nothing else, realized volatility is overwhelmingly likely to remain elevated as this resolves.

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

It seems like only a week or two ago when I last complained about churn. Damn, I miss those days.
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We've gone from lazy churn to downright panic in the course of a few days. And make no mistake, this is a panic for the ages, at least as far as our CBOE Volatility Index (VIX) goes.

VIX closed 81.7% above its 10-day simple moving average (SMA), the biggest stretch ever. We usually use 20% above the 10-day SMA as a trigger, and it only happens about 3-4 times per year, including Thursday.

Thirty percent above the 10-day? I show it happening 43 times total since early 1993. That's 5,690 trading days. And even that overstates it, as some of those are bunched and essentially part of the same "incident." If I winnow out bunched dates, I show 21 separate incidents of VIX 30% above its 10-day SMA. Again, that's in a 22.5-year time sample -- so, as best my "back of the envelope" math tells me, that's less than once per year. And here are they are:

Yes, the current pop only "counts" as a 36% violation using the 30% threshold. As you can see -- thanks to my wonderful color coding -- the SPDR S&P 500 ETF Trust (SPY) returns look pretty good when you buy after a close this extreme. Six of the seven top incidents with larger violations than this one saw one-month and three-month returns nicely above typical one-month and three-month returns.
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What if we increase the threshold to 40%? We're down to eight incidents, including the current one:

It's only seven priors, but the returns look pretty strong. The worst case three months out was buying in May 2010 -- just before the "flash crash," as it turns out. You were basically flat. The next worst case was April 1994, and you had returns almost exactly the same as buying on some random date. Every other time, you did very well. Overall, it's a 7.85% average and 9.13% median vs. 2.06% average and 2.79% median on a randomly timed purchase.

You did very well buying and holding for one month as well -- 2.93% average and 3.05% median vs. 0.68% average and 1.11% median. There was one accident -- the flash crash.

The sample size is low, and again, we do crash from oversold. But odds are we got a bit extreme here, and it may be a good time to buy if you can stand some pain along the way.

And one thing that I think is important to note: All of the above mega-extremes took place in otherwise decent markets. There are no 2008s or 2002s thrown in. That's because those were longer-term ugly stretches amid already rising volatility. These were more sudden bursts. Maybe it's like February 2007 and it's an early warning shot. But remember, even then, the market recovered and made new highs into October.

What's conspicuously absent? The Crash of '87. VIX didn't exist then, and neither did SPY, for that matter. But alas, we can get back there in a way -- and we'll do exactly that later this morning, in Part 2 of our analysis.

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

As I mentioned in Part 1 of this series, there is a way to go back further in time and look at volatility blasts, even in the absence of a volatility index. Long story short, before there was the CBOE Volatility Index (VIX), there was the CBOE OEX Implied Volatility Index (VXO). VXO was -- and is, as it still exists -- a volatility index that proxies 30-day implied volatility on S&P 100 Index (OEX) options. Prior to 2004, the index now known as VXO was known as ... VIX. The index now known as VIX didn't exist yet.

Think of VXO as "Original VIX." As I mentioned, it proxies volatility on OEX options, because back in the '80s and early '90s, OEX was the busiest option around. It also only uses near-the-money strikes in its calculation, whereas current VIX uses a much larger and varying number of strikes. Thus, current VIX factors in many high vol out-of-the-money puts, whereas original VIX did not.

So, how does VXO help us at all? The data stream goes back further, all the way to 1986 -- even though it didn't start as a published index until the early '90s. Thus, traders during the '87 crash didn't actually "see" original VIX hit 150 because it didn't exist yet. I'd note that from my experience as a floor trader from the late '80s into 2001, no one paid much attention to VIX anyway; you just knew volatility.

Anyway, here's Vol Pops: VXO Edition. It's similar, but not identical to, using VIX. That is to say, inferior methodology, but more data to work with. Here are all the days where VXO closed 40% above its 10-day simple moving average (SMA), as well as the one-month and three-month returns in OEX, if you bought the close those days.

Last Friday was actually the fourth biggest stretch ever -- though, as you can see, the first two were rather insane. Also, your performance timing a fade into the crash depended entirely on what day you faded -- which is a good argument for using an averaging strategy, if you are of a mind to fade now.

How about our "40%" strategy? Go long when VXO gets 40% above the 10-day, hold for one month or three months.



Well, now we have 15 separate incidents vs. eight when we just used VIX and only went back to 1993. And it includes a disaster trade from the '87 crash, as well as a mediocre one from 2008. Even with that, the one-month results are pretty much nothing. You won nicely eight times and won slightly twice, while losing four times. Out three months, we actually beat the market on the average results, 3.67% to 2.17%.

The scary similarity to now is that 1987 started out with a couple ugly days into expiration, followed by a disaster the day after expiration. Back in 1987, there were no weekly or dollar strikes, so part of the issue was a market cascading between strikes much further apart in both absolute and percentage terms.

Remember, on expiration, deltas go "binary" -- everything's either zero or 100. Short option squeezes forced selling into the next strike, and the next short option squeeze. Today, with weekly and tight strikes, tons more derivatives and like products, there's way more moving parts to play with. So it's not clear the similarity is that big a deal. The encouraging sign, though, is even including 1987 numbers, fading the biggest VIX rips didn't fare badly net-net.

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

The S&P 500 Index (SPX) got hammered last week, along with its fellow market indexes. In fact, the broad-market barometer dropped 2.1% on Thursday, another 3.2% on Friday, and is poised to surrender yet another 3% today -- which would mark the first time in 13 years the SPX has given up 2% or more in three straight sessions.

Per Schaeffer's Senior Quantitative Analyst Rocky White, this signal could suggest more volatility ahead, if history is any guide. Going back to 1928, this steep a sell-off has happened just 13 times (nine in the Great Depression era), and the SPX has been positive in the subsequent week less than half the time -- compared to 56% of the time under "normal" circumstances. The average one-week loss is 7.3%, compared to a 1.9% anytime loss, while the average one-week gain is 8.7%, compared to 1.7% anytime. 

Going out to six months, the SPX has been positive after a steep sell-off 54% of the time, with an average loss of 26.4%, and an average gain of 24.5%. On the flip side, the SPX anytime six-month returns are positive two-thirds of the time, and volatility has been relatively muted, with an average loss of 10.4% and an average gain of 10.8%.  

 

So you think we make a big deal about CBOE Volatility Index (VIX) moves here? Maybe we err on the side of not giving it enough value:

Barclays slays it: "we find that the sharp rise in the VIX weighs negatively on activity and employment "

— zerohedge (@zerohedge) August 24, 2015

I'm not sure where to start on this one. Here's my favorable interpretation: Perhaps in 2008, there was a time where VIX was high and the economy was weak, and someone's mistaking a concurrent event for causation. Here's my unfavorable interpretation: Um, what? Did someone really say that? Maybe they lost their job at Barclays for blaming VIX for employment dips.

Anyway, what is there really to be said about yesterday's trade that hasn't been tweeted 500,000 times already? I focus on VIX because, hey, that's what I do -- I have an options and volatility background. But you didn't need a VIX in 1987 to tell you the market and market volatility had gone insane. Again, VIX didn't exist yet. Any numbers I provided, and numbers others provided, are backdated calculations of where VIX would have been then. Remember, it's just a calculation. It's a formula based on the implied volatility of the underlying. In 1987, that underlying was the S&P 100 Index (OEX); now, it's the S&P 500 Index (SPX).

No, the market didn't make anything close to the percentage move it made in 1987. Volatility -- as gauged by VIX -- did, however. At its high of 53, it was about 280% above its 10-day simple moving average. That's about where it closed on the crash day of '87.

It's apples to oranges -- CBOE OEX Implied Volatility Index (VXO) methodology to VIX methodology, OEX underlying to SPX underlying -- so it's not an exact comp. But it's close enough, and let's get something straight about all these ratios I throw out there: I use them to make comparisons and so on. They give generally good guidance, but like anything, they can go haywire. There's no natural support or resistance in a ratio -- particularly one that's comparing one math calculation to another. It's a good indication when a move has gotten extended, but as you can see, it's not gospel. Nothing is ever gospel.

Why use ratios and moving averages as opposed to absolute numbers? Well, think of VIX as proxying the degree to which the market prices in a certain move. At 16, VIX basically prices in moves of about 1% in the market. Thus, when the moves go beyond that bound, someone's getting squeezed. When moves go way beyond that, the squeeze is exploding.

The moving average of VIX gives you a modestly better guide of what's really priced into the market. It's the "mean" to which we expect reversion at some juncture. When VIX itself gets stretched from that mean, it's a good proxy for the degree of squeeze on the shorts. Most of the time that runs its course -- but on rare occasions, it has the exact opposite effect, and compounds and compounds the short options' pain. This is clearly one of those times. That's why, to me, this VIX storm is the second largest on record, surpassed only by 1987, even though VIX itself is not historically high.

History doesn't repeat so much as it rhymes a bit. It's really not 1987 anymore. For one thing, my kids aren't much younger now than I was then, which is a strange concept. For another thing, the Mets aren't the defending World Series champs, nor are the Giants defending Super Bowl champs. Come to think of it, bring back 1987!

Actually, 2011 is probably a better parallel. VIX had a bit of a higher baseline, and didn't move quite as rapidly, but it did lift from 17.5 on July 22 to 48 on Aug. 8, while the market dropped 16.5%. We remained shaky for the next three months, and briefly made lower lows in October, and then the rally eventually resumed. It sounds like a realistic template for what we might see going forward now.

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

Some notes from the VIX-plosion. A friend of mine who is very familiar with hedge funds sent me this on Monday during the implosion:

"For what it's worth, a lot of what's going on is lack of liquidity (no market makers) and margin calls all over the place. What people forget is that 90% of all hedge fund money is now run by 100 firms. These firms are almost exclusively multi-strategy. Therefore, if they hit their firm-wide loss limit, every strategy needs to reduce exposure regardless of their p/l. That is why you get a correlation of 1.0 across all assets. People still don't get that.

"Also, in large moves like this, you don't get tick by tick margin calls. So after Asia close, you get grossed up on your margin calls, so you sell in Europe. Europe has large losses, so you get grossed up again with another margin call in the US. It is a daisy chain capitulation trade. People think that margin departments can calculate margin calls real time. In reality there is some lag, especially when markets move so fast and they have so many margin calls to make."

I'm pretty sure one of the strategies involves selling all these overpriced CBOE Volatility Index (VIX) calls. Well, formerly overpriced. VIX options trading is a relatively small part of the market, and unlikely to have "caused" the cascade. Variance trading as a whole, though, is pretty big, and there's an awful lot of zero-sum trades where someone is necessarily on the wrong side.

The CBOE VVIX Index (VVIX) is the VIX of VIX; it proxies the volatility of VIX options. And it made quite the move this past week:

It went from 91 last Wednesday to a high of 212 on Monday, which was its highest reading ever (we've only had VIX options for a decade, so "ever" isn't that long). In other words, it moved similar to VIX. VIX options have huge positive skew, so, thus the speed of the VIX move, combined with the fact that now much higher strike options are at the money, made this the perfect VVIX storm.

I'm sure the actual damage to a VIX call short is pretty bad. But, it's not quite as bad as meets the eye. That's because VIX futures don't actually assume this VIX pop is permanent. Here's how the term structure looked before Tuesday:

Yes, VIX is always going to 20 in half a year, whether actual VIX now is 12 or 42.

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

This CBOE Volatility Index (VIX) pop isn't exactly in the rearview yet -- but hey, we can still throw out some interesting comps to VIX pops of years past!

VIX and the S&P 500 ETF Trust (SPY) have an inverse relationship, as we all know. Over the course of VIX history, there's a correlation of negative 0.71. Square that, and it implies that the move in the S&P on a given day explains about half of the VIX move. That sounds about right, since VIX ostensibly looks forward. It proxies implied volatility 30 days out, and that implied volatility is more or less an estimate of the volatility the S&P 500 Index (SPX) will actually realize.

So, another way we look at it is that VIX is half-looking backward, and half-pricing forward. And since we know backward, we really want to solve a bit for "forward." In other words, what's the unexplained move in VIX in a given day?

Since inception, VIX moves about negative six times the move in SPY. Ergo, if SPY drops 1%, we'd expect to see VIX rise 6%. Of course, that assumes a linear relationship -- and in reality, VIX often reacts a bit more when the move in SPY is larger. If we look at the 100 largest one-day VIX moves ever, they moved about negative 6.7 times the SPY move. If we narrow that down to the top 20 VIX one-day moves, it's about negative eight times the SPY move.

Anyway, with all that in mind, I wanted to see how the recent pops stack up in the context of VIX-story. Here are all the instances where VIX popped 30% in one day, going back to 1993, as well as the ratio of the VIX move to the SPY move.

We actually just saw the third- and fourth-biggest one-day VIX moves, in percentage terms, since 1993. Pretty impressive! If you're of the opinion that it looks similar to 2011, well, that's the only other time VIX pops clustered like this. We see three within a 10-day period in August 2011, as well as another one in September, and then a final blast in November before the all-clear whistle blew. So, only three more months of this to go!

And how about if we rank these pops by the degree to which VIX moved vs. SPY?

Well, we're kind of in the middle. We overreacted a bit this go-around, but not historically so. And it doesn't say a lot for future market moves; it's pretty much all over the map.

So I guess it's more evidence that these pops were historic, but looking at it through the one-day lens, not terribly predictive.

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

For CBOE Volatility Index (VIX) futures traders -- the ones that go long: It's the best of times. Here's a comparison of the VIX term structure on Aug. 17, just before the market broke down, to the term structure on Friday, Aug. 28. In other words, here's what happens to futures when VIX doubles in a little under two weeks:

Kind of/sort of/kind of what you'd expect. Near-term futures ramped up 10 points, eight-month futures about 3.5, and everything else somewhere in between. I'm sure the guy holding futures in the middle there might wonder why he didn't get a bigger pop, but really, it makes some sense. Futures price in some degree of mean reversion in VIX. The pop was like lightning, so if nothing else, VIX will have to stay elevated a bit longer for the outer months to start believing it's going to last.

But alas, we know VIX rose faster than that. It peaked on both an intraday (53) and closing (40.74) basis on Aug. 24. So how about we add the term structure from that day to the graph:

If the term structure on Aug. 24 looks pretty identical to the term structure on Aug. 28, well, that's because it is virtually identical. Another way to look at it is that VIX dropped 14 points, about 35%, and VIX futures barely budged. The nearer-term futures dropped modestly, and the outer months actually lifted.

It's as good a reminder as any that VIX futures are NOT VIX. They price in mean reversion. Since the long-term mean of VIX is near 20, they tend to pivot around that level. If VIX is below 20, they "predict" a VIX rally. If VIX is above 20, they "predict" a VIX decline. They're right in the sense that VIX always revisits pretty much everything. But don't assume they're "smart" in any way, shape, or form.

That green line on the bottom has existed pretty much always over the last four to six years. And it's mostly wrong, as VIX mostly doesn't lift as much as futures price in or in as sustained a time frame. But occasionally they're "right." So is a broken clock, for that matter.

This go-around they were "right" in a big way -- perhaps the biggest way ever, when you consider that options on VIX futures had an unprecedented price explosion. And that blast paid for an awful lot of wrong calls on VIX. The players that endlessly rolled out worthless VIX call longs finally hit the lottery.

And I think that's the whole point of buying them, or any sort of VIX paper. It's insurance and it's cheap-dollar speculation on a volatility explosion. It's mostly not going to work, but on occasion it will, and on rare occasions, work incredibly well.

Right here, right now, it's a little odd that VIX futures didn't give anything back as the market lifted and VIX dipped. Smart money, though? We'll see, but I'd guess more along the lines of "trapped money" for anyone on the wrong side of this and trying to get back to whole again.

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

What if we suddenly woke up in a world where the CBOE Volatility Index (VIX) stopped updating? We got a window into that Dystopian Hellscape during last week's implosion, as Bloomberg recounts:

"Among the many scary things traders witnessed as stocks plunged last Monday, one of the most harrowing was the sight of the VIX, an index designed to measure investor fear, briefly going dark.

For almost 30 minutes as hundreds of billions of dollars were erased from equities, no signals were sent by the world's most popular sentiment gauge as options prices turned erratic. When it switched on, the VIX jerked higher faster than anyone had ever seen, rising 82 percent on its first tick to 51, a level not reached since the financial crisis." 

It is kind of funny how we've come to hypothesize about the meaning of every VIX tick over the years (and yes, guilty as charged). It didn't exist in 1987, and no one really paid any attention to it until maybe 2002. Now it's gospel and it's traded via 500 different derivatives or so. 

Speaking of which, Bloomberg continues:

"Besides the VIX going dark, the most visible manifestation of the deluge was volume in futures tied to the VIX. In the hour before the market opened Monday, traders exchanged 78,000 of the September contracts, more than four times the average at that time in the 20 days prior, Bloomberg data show.

Traders were nervous, naturally. Some had to cover short positions in VIX futures, essentially bets on a rising stock market that had worked for years. Hedge-fund managers were net long more than 16,000 of these VIX contracts through Tuesday, as opposed to a net short 55,000 positions on Aug. 18, according to U.S. Commodity Futures Trading Commission data."

I don't believe VIX derivatives in any way caused the panic -- they're just not big enough. But I absolutely believe they added fuel to the fire between the price spike and the options volatility explosion. They're more dangerous than straight short puts in that they're open-ended and not backed by the fundamentals of an underlying company or index; it's based on a calculation, and that number knows few upward bounds. So the prospect of those sort of losses can certainly impact behavior, and not having an actual VIX to look at likely didn't help matters. 

The iPath S&P 500 VIX Short-Term Futures ETN (VXX) was the first VIX derivative exchange-traded note (ETN), and it's by far the biggest and most influential in the somewhat crowded space. And last Monday was indeed an extraordinary day, as it ran up $6.4 billion worth of dollar-weighted volume, an all-time record.

VXX dollar-weighted volume does trend up over time, very much exponentially from the early days. But even in that context, it was quite the spike. Here's a graph of dollar-weighted volume back to Day 1:

And yes, you'll need a magnifying glass to see anything before 2012, that's how popular VXX has become.

Here's a fun fact: VXX first listed on Jan. 30 2009; if you added up the dollar-weighted volume every trading session, it didn't surpass last Monday's dollar-weighted volume until May 16, 2011. In other words, the Aug. 24 session was as busy as the first 577 trading sessions combined. That's how fast this product has grown.

So, next time I make fun of VXX, remind me of this. And also remind me that this whole VIX complex is a bit of a tinderbox that can catch fire at a moment's notice. 

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

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:

@agwarner What would have happened if a $VIX future was due to settle that morning in which there were no $VIX prints?

— Eli Mintz (@VixCentral) September 1, 2015

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