Trading volatility is nothing new for option traders. Most option traders rely heavily on volatility information to choose their trades.
Until recently, traders used regular equity or index options to trade volatility, but many quickly realized that this was not the best method.
In this article, we take a look at the past performance of the VIX and discuss the advantages offered by the VIX options. VIX options give traders a way to trade volatility without having to factor in the price changes of the underlying instrument, dividends, interest rates or time to expiration - factors that affect volatility trades using regular equity or index options. VIX options allow traders to focus almost exclusively on trading volatility.
Diversification Traders have found the VIX very useful in trading, but now it provides superb opportunities for both hedging and speculation. It may also be an excellent tool in the quest for portfolio diversification. Diversification, which most people consider a good thing, is useful only if the instruments used are not correlated. In other words, if you own 10 stocks and they tend to move together, then you really aren't diversified at all. On average, VIX has risen This makes it an excellent diversification tool and perhaps the best market disaster insurance.
In , the VIX reached its highest close at It bottoms out around 10, because if it were to go to zero, that would mean that the expectation was for no daily movement in the SPX.
On the other hand, the VIX has spiked upward to around 80 when the SPX has dropped, but for the VIX to stay there would mean that the market expectation was for very large changes over an extended time frame. This makes the new VIX options excellent speculation instruments as well. Similarly, buying puts or bear put spreads , or selling bear call spreads can help a trader capitalize on moves in the other direction.
Another factor enhancing the effectiveness of VIX options for speculators is their volatility. However, this is still higher than most stock options out there. An instrument that trades within a range, cannot go to zero and has high volatility, can provide outstanding trading opportunities. VIX Facts Unlike standard equity options, which expire on the third Friday of every month, VIX options expire on one Wednesday every month; there is no question that these options are being used, thus providing good liquidity.
For all of March - the first full month of trading for VIX options - total volume was , contracts, with an average daily volume of 7, At the end of March, open interest already stood at a very healthy , contracts. In February of , the volume for options averaged above , The Bottom Line All of this means that option traders now have a new instrument to add to their trading arsenal, one that isolates volatility, trades in a range, has high volatility of its own and cannot go to zero.
For those who are new to option trading, the VIX options are even more exciting. Most people who focus on volatility trading are both buying and selling options, but new traders will often find that their brokerage firms do not allow them to sell options. By buying VIX calls or puts or spreads , new traders can now have access to volatility trades. Dictionary Term Of The Day.
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