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January 13, 2009  Tue 9:52 AM CT

VIX: SEE CHART GET CHAIN FIND STRATEGIES

The VIX is up more than 1 percent even as the S&P moves into positive territory, once again bucking their usual relationship of trading inversely.

The volatility index is up to 46.28 as the SPX pushes up to 872.69. The nearest-month VIX future is at 47.72, and February is up at 47.79. March is lower at 43.40.

This data is a good background for looking at VIX options. VIX calls can present an interesting alternative for portfolio insurance.

Many institutional traders, and some self-directed "retail" traders, use S&P 500 puts for portfolio insurance. But VIX options can be used in their stead, and their very nature (and origination) are based on that premise.

I read two blogs this morning that suggested buying VIX calls. The first is by Andrew Snyder on TodaysFinancialNews.com, who recommends buying specific January or February contracts. The second is from the OptionsUniversity Blog, which also recommends VIX calls and points out some good reasons for considering them as an alternative to S&P 500 puts.

The problem here is in relative value. You need to be very clear when talking about the spot VIX and the VIX options. The VIX options are priced off the VIX futures, not the spot reading of the volatility index. And VIX futures are, on the whole, less volatile than the spot value--a contrast that gets more pronounced the farther out in time you go.

Because the spot VIX gives us a relative value of the SPX puts, we can compare the two values. The January VIX futures are at 47.72, and the VIX calls are priced off that value, not the lower spot VIX. So the SPX puts are relatively cheaper than the VIX calls.

The timing of these recommendations is ironic. The spot VIX was higher than the futures from mid-September until last month, and at that time VIX calls would have been a better purchase than SPX puts from a relative value perspective.

Please don't worry if the above discussion finds its way over your head. It is quite complicated, and I have talked to many Ph.D risk managers who also don’t understand it either. The most valuable lesson out from the discussion is this: If you don't understand it, don't trade it.

 

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