VIX Goes Global, But Will It Translate?

The CBOE announced Tuesday that they're going to license the methodology used to derive the VIX to other global exchanges:

"The Indian exchange, the NSE in India, recently took up a license from us," CBOE Chief Executive William Brodsky said at the Reuters Exchanges and Trading summit in Chicago. "This is a new and growing source of revenue for us as well."

The move would eventually help Indian investors understand and trade volatility as an asset in the U.S. market.

"It's something that helps solidify our brand and get more attention to the products," Brodsky said. "So people understanding volatility in India, they're certainly going to want to trade volatility in the U.S. and that will rebound to us."

Brodsky said he plans to attend the annual general assembly of the International Option Market Association this week where he already has people lined up who are interested in CBOE's volatility products. [link]

Our biggest concern is about the kind of interest that has developed in volatility products. If traders are adding volatility to the chest of analytical tools that they use, that's great, especially if the audience is expanding beyond options traders. But if the CBOE's banner ads all over the web are any indication, by "volatility products," Brodsky probably means not just the indexes, but options on the VIX as well.

And that's not especially good news, because VIX options honestly aren't very helpful to retail traders, tempting as they might be.

VIX options respond differently to price and to time than do ordinary equity options, and for the purposes of hedging a stock portfolio are still inferior to ordinary index options. Adam Warner and others have consistently done yeoman's work warning people off these products (example), but it may be that the prospect of the occasional giant one-day spike is simply too tantalizing.

The point, however, is that the spike you see in tomorrow's VIX isn't the movement that drives the VIX options you're holding - they're priced off of VIX futures - and you can't reasonably hedge those contracts over time, since the longer dated contracts price in mean reversion in a particularly nasty way. Volatility indexes are great as sentiment gauges, and poor as trading vehicles.

Comments

[kaps]

A beginner here. AFAIK, VIX is calculated using weighted average of range of options on S&P500. I am not sure what an option on VIX would mean..whether it will help investors hedge better against the volatility or is it just a tool in hands of speculators which will end up introducing more volatility into the market??