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“When the VIX is at 10 realised
volatility will be at 5 or 6. We don’t
trade the VIX—our focus is on
index options on the S&P 500. That
is the deepest and most liquid mar-
ket so the liquidity cost is minimal.
Rolling down the VIX curve can
be tricky. The VIX takes the delta
component out of the equation but
VIX derivatives are less liquid and
more able to be manipulated. VIX
is a reference for us not a driver.”
Stefan Rondorf, senior invest-
ment strategist at Allianz Global
Investors, agrees: “The VIX is a
kind of mathematical construct,”
he says. “While buying protection
is relatively cheap from a historical
point of view, you don’t get it for
free.”
Using rolling VIX futures creates
a negative cost of carry as forward
months are priced higher than
near months meaning investors
have to pay more to roll over their
positions from month to month. At
the same time the futures contract
will only imperfectly track the
underlying VIX index. While the
VIX spiked 44% to close on 16.04
on August 10th, short-term futures
rose to a high of 15.55.
“The idea is that traders believe
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Autumn 2017
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“The trading activity we’re seeing now could be
investors beginning to get out of short volatility
trades.”
RUSSELL RHOADS, DIRECTOR OF EDUCATION, CBOE OPTIONS INSTITUTE
that any spike will come down
quickly so there is a futures dis-
count,” says Rhoads.
There are other ways to trade
the VIX. The aforementioned
ETNs have been popular in recent
years—though these are potentially
even less efficient then trading the
futures contract.
“VIX ETNs, levered and inverse,
those are more of an unknown,”
says Selvala. “What will happen
when markets go haywire? These
products are forced to buy more as
it gets higher. We have not seen the
full effect of these, right now they
are still small.”
The issues with the VIX have led
to participants calling on use of
other benchmarks as a better gauge
of volatility.
Last November, Hyun Song Shin,
head of research at the Bank for
International Settlements, said the
dollar was a better gauge of bank
leverage than the VIX. Meanwhile
exchange operator Bats Global
Markets issued a new volatility
index linked to S&P 500 SPDR ETF
issued by State Street which it has
called more “rigorous and depend-
able” than the VIX. It is relevant
because it seems that the volatility
trade could get even busier later
this year.
“We have been in the lowest
period of realised volatility since
we have had the S&P500,” says
Rhoads. “The market is in a very
riskless environment right now, but
from a historical or seasonal per-
spective, the third quarter is when
many volatility events happen. The
trading activity we’re seeing now
could be investors beginning to get
out of short volatility trades.”
It is likely to be an interesting
time making the right instrument
choice all the more important.