In today's Market Measures segment, Tom Preston sits in for Tom Sosnoff as he is out of town. The topic of discussion today is gaining exposure to VIX futures (/VX) on a smaller or modified scale.
When trading volatility, one can buy or sell VIX futures, which generally ties up more than $5,000 in margin and has a notional exposure of $1,000 per point in the future. For many, this might be much too large for their account size. So, how can you make the same trade as buying or selling VIX futures on a smaller size? The answer lies in the VIX options, which are priced to the VIX futures.
While the VIX index and VIX futures will differ in price, the VIX options are actually priced to the corresponding VIX future. For example, the current June VIX options are priced to the June VIX future contract. This is because both VIX options and futures are forward-looking instruments, and settle to the same value on the day of VIX settlement.
One options contract on the VIX has notional exposure of $100 per point, while the VIX futures have $1,000 of exposure per point. So, a 10-lot synthetic combo in the VIX options would be needed to replicate one VIX future. A synthetic combo consists of buying a call and selling a put at the same strike and in the same expiration for long volatility exposure. For short volatility exposure, a long put and short call combo at the same strike and expiration would be used. For example, if the June VIX futures were trading at $16, the long 15 VIX call and short 15 VIX put in June VIX options should be trading for about a $1.00 debit, bringing the cost basis for the strategy to $16 or the same as the June futures contract.
One long/short synthetic in the VIX options would be equivalent to 10% of a VIX future. If a trader wanted half the exposure to a VIX future, they would trade a 5-lot synthetic VIX combo in the VIX options with the same expiration as the futures contract they wanted exposure to.
Join Tony Battista and Tom Preston for their own personal insights into this important topic!
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