Today we look at the differences between VVIX and VIX.
We’ll discuss the basics of the two indices and then things to look out for in your trading.
When it comes to volatility products, investors are often confused.
This article provides a brief overview of two major volatility indices.
The VIX and VVIX. We will then examine similarities, differences and comparisons between the two products.
VIX is an index that represents market expectations for volatility over the next 30 days.
This index is derived directly from a large basket of various SPX options.
This allows the index to account for things like skewness and curvature.
Essentially, it gives a good overall picture of implied volatility via the S&P 500 interface.
Hence, the VIX shows a snapshot of the implied volatility for the S&P 500.
VVIX is an index that measures the volatility of the VIX index over the next 30 days.
The methodology is almost the same, but instead of using SPX options, the VVIX uses VIX options. It therefore measures the volatility of volatility.
For the sake of simplicity, it is often referred to as vol-vol. designated.
The VVIX shows a snapshot of the implied volatility for the VIX.
Yes, VVIX is a derivative of VIX. Just like our first level Greeks like delta, theta and vega have their own derivatives.
They are second order Greeks like gamma, vomma and vana.
We then have 3rd order Greeks derived from 2nd order Greeks. It’s just like in the movie Inception!
Source: meme generator
The idea that we can go deeper and deeper math can make options seem daunting.
Though don’t fret.
When we get to the 3rd and 4th order Greeks, they lose their importance for retail and are mainly only relevant for market-making companies.
The main focus of options traders should be on the first orders from the Greeks.
The same applies the VIX. If you don’t fully understand the VIX, stop and find out before diving into products like the VVIX.
After all, the VVIX does not exist without the VIX.
If you don’t understand the VIX, it’s impossible to understand its derivatives.
I mentioned that they are less and less important to the average retailer as you go down the list of derivatives.
For most people who are into vanilla single name options, VVIX doesn’t really matter.
However, an exception must be made for VVIX.
The uniqueness of VVIX is that it is easy to trade directly through trading VXX options.
Most likely you or someone you know acted VXX options as “hedge” or for speculation.
Best of Options Trading IQ
Most of the people who trade VXX options think that they are trading the volatility of the S&P 500.
However, by buying and selling options on VXX, you are actually trading the volume of Vol or VVIX! If they wanted to trade the VIX directly, they would simply buy or short the VXX as it already measures the volatility of the S&P 500.
Fortunately, most of the time, both products move in a similar manner, as we’ll see later.
Unfortunately, this also prevents investors from learning what they are actually act when trading VXX options.
One of the greatest similarities between the two products is that they are both indexes.
As such, they cannot be traded directly.
Trading with VIX is about trading VIX futures and VVIX is about trading options on these VIX futures.
Another similarity between the two products lies in their high correlation.
Below I drew a diagram of the VIX vs. VVIX (in red). We can see how correlated they are with each other.
Source: Yahoo Finance
Why are they so correlated? Let’s think about it logically.
When does the VIX move up and down the fastest?
If you are in times of. think Market stressthen you are right.
This happens when the VIX is already high. A simple analogy looks like this.
If it is sunny today, it is likely to be sunny tomorrow.
If there is a storm today, it may be calm tomorrow or there could be a hurricane.
VVIX measures this uncertainty about tomorrow’s volatility.
So does it have to be that VVIX is also high when VIX is high?
For example, if the market were to enter a new, more volatile regime and there was little doubt that lower volatility would return in the future, it would mean a high VIX and a lower VVIX.
But even then, the divergence must not be too pronounced.
Due to the high correlation between VIX and VVIX, one strategy could be to trade against each other and bet on mean reversion.
This is because VIX and VVX will converge over time as they are both mean-reverting and correlated assets.
For example, if a trader thought the VVIX was high versus the VIX, they could buy VXX stocks while selling VIX calls.
This could express an opinion on the VIX / VVIX ratio.
Don’t just call it part of a covert calling strategy!
Alternatively, imagine we are looking to hedge our equity position.
The first place we should always look for coverage is in the position itself.
For example, if you are long stocks of the S&P 500, SPX puts are a better hedge than long VIX.
Don’t just happen to buy insurance for your neighbor’s house instead of your own.
Sure, it might work sometimes, but it’s better to offer it at a discount.
The same is true for a short volatility portfolio.
The best protection here is to buy and sell the VIX directly, not the VIX options.
That being said, there are rewards for being tactical and trading VVIX vs. VIX based on your point of view, if you are correct, while also providing relatively good protection for your holdings.
Both the VIX and the VVIX are similar. While the VIX measures the implied volatility of the S&P 500, the VVIX measures the implied volatility of the VIX.
Both indices are correlated and often move together, which makes for good pair trading.
Even so, they are not the same and can occasionally move in different directions.
Nor can they be traded directly.
An exposure to the VIX can be achieved by buying or selling VIX futures or VXX, while an exposure to the VVIX can be achieved by trading options on these products.
The most important thing is whether you are trading VIX or VVIX. Know what you are trading and why you are trading it.
Disclaimer: The information above is for For educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are unfamiliar with exchange-traded options. All readers interested in this strategy should do their own research and seek advice from a licensed financial advisor.