This timely segment focuses on volatility derivatives and specifically upon the relationship between VIX futures and options and their relationship, including important hedging calculations, to the VXX ETF (with a small reference to UVXY),. Anyone trading these products will benefit from the information here and is more likely to get into trouble without that info.
The VIX options and futures (/VX) are some of the most commonly used derivatives to gain exposure to market volatility. Another important product is the VXX ETF. The VXX traded 270 million shares on August 24th when the market experienced a freefall followed by a vicious rally. That kind of volume shows it is a liquid trade. That led some viewers to ask about the ratio used when hedging /VX futures with VXX.
There is a “perfect hedge” for VIX futures to VIX options. One should use 10 VIX option contracts against every 1 /VX future but when it comes to VXX it’s not so simple. VXX was designed to provide daily volatility exposure via a combination of the first and second month /VX futures but to simplify things we’ll focus on VXX in relation to the front month /VX future.
The correlation of daily returns between VXX and the front-month /VX future has 0.82 since the beginning of the the ETF iin 2009, The VXX fund holds a combination of the first two month /VX futures and the price of the fund has varied significantly at times from the futures because of the design to mimic daily returns and not long term returns. Because the price of VXX varies, the number of shares needed to hedge /VX also changes:
Tom and Tony go through an example that demonstrates it. A table supplies the relevant numbers. They then reveal the calculation needed for hedging. They also explain how the hedge ratio has varied widely over the years. This was also proven through a visual display. Some more examples showing how large the differences can be were also provided. Tom also referenced the UVXY ETF.
Takeaways:
The ratio between /VX futures and VIX options (10 VIX options to 1 /VX future) is static, but the number of VXX shares to hedge 1 /VX is not When VXX is trading at a higher price than /VX, less shares of VXX are needed to hedge, and vice versa.
Watch this segment of “Market Measures” with Tom Sosnoff and Tony Battista for the second takeaway and the calculation you need to know to hedge a /VX position using the VXX.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.