From what I have read VIX on various sites "VIX options are european style options and hence can only be exercised on the expiration date". I'm confused. So if I buy VIX calls, and get lucky and they appreciate in value before the expiry date/month, can I sell them back to the market like usual?
Yes, you can close positions in VIX options as you would any option -- as you mention, it is the inability to exercise before expiration that is different from a traditional american style option. However, as so few options are actually exercised anyway and the vast majority of positions are simply closed ahead of expiration, it's not all that different from what you would likely do for any other option. They are cash-settled so you could theoretically wait until the settlement to get your profit if it's in the money, if you wanted, but most will choose to close, particularly given the sometimes overnight shenanigans that happen with VIX options, as the settlement is based on the opening print on the morning of expiration and strange things can happen overnight.
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1. Your brokerage account needs to be a margin account, and you need to sign up for options trading. There are various levels of option trading available (e.g., the first level allows covered calls). My experience is that to trade VIX options you will need to be authorized to trade at the second level. These levels vary from brokerage to brokerage, so you will have to ask what is required to be long VIX options. If you are just getting into options trading this is as high as you want to go anyway. Selling naked calls for example is not something for a rookie to try.
2. No special permissions are required from your broker for VIX options. In general the same sort of restrictions (e.g., selling naked calls) that apply to your equity option trading will apply here.
3. Calendar spreads aren’t allowed (at least within my account, with my level of trading). The software didn’t prevent my entering the order, but the order was cancelled once I entered it and I got a call from the broker—ok, what did I do now? The reason for this restriction is because the options from different months don’t track each other well. More on that later.
4. The option greeks for VIX options (e.g. Implied Volatility, Delta, Gamma) shown by most brokers are wrong (LIVEVOL and Fidelity are notable exceptions). Most options chains that brokers provide assume the VIX index is the underlying security for the options, in reality the appropriate volatility future contract is the underlying. (e.g., for May options the May VIX futures are the underlying). To compute the correct greeks yourself go to this post.
5. Because the underlying for VIX options is the futures contract, the options prices do not track the VIX particularly well. A big spike on the VIX will be underrepresented, and likewise a big drop probably will not be closely tracked. This is huge deal. It is very frustrating to predict the behavior of the market, and not be able to cash in on it. The only time the VIX options and VIX are guaranteed to sort-of match is on the morning of expiration—and even then they can be different by a couple of percent.
6. The VIX options are European exercise. That means you can’t exercise them until the day they expire. There is no effective limit on how low the prices can go on the VIX options until the exercise day.
7. Expiring In-the-Money VIX options give a cash payout. The payout is determined by the difference between the strike price and the VRO quotation on the expiration day. For example the payout would be $1.42 if the strike price of your call option was $15 and the VRO was $16.42.
8. The expiration or “print” amount when VIX options expire is given under the ^VRO symbol (Yahoo) or $VRO (Schwab). This is the expiration value, not the opening cash VIX on the Wednesday morning of expiration. VIX options expire at market open on expiration day, so they are not tradeable on that day.
9. VIX options do not expire on the same days as equity options. It is always on a Wednesday before or after the Friday equity option expiration date. See this post for upcoming expirations. This odd timing is driven by the needs of a straightforward settlement process. On the expiration Wednesday the only SPX options used in the VIX calculation are the ones that expire in exactly 30 days. For more on this process see Calculating the VIX—the easy part.
10. The bid-ask spreads on VIX options tend to be very wide (e.g., 0.5) . I have always been able to do at least .1 better than the published prices–always use limit orders. If you have time start halfway between the bid-ask and increment your way towards the more expensive side for you.
11. I don’t recommend you start trading options on VIX if you aren’t an experienced option trader. If you are a newbie trade something sane like SPY options first…
12. The VIX is not like a stock, it naturally declines from peaks. This means its IV will always decline over time. VIX options as a result will often have lower IVs for longer term options—not something you see often with equities.
13. The CBOE reports that trading hours are: 7:30am to 4:15pm Eastern time, but in reality the options do not trade until after the first VIX “print”-when the VIX value in calculated from the first SPX options transactions. The first VIX quote of the day is usually at least a minute after opening.
I am experimenting with VIX options. So this is a newbie question -
VIX option last trade is reported in penny increments, but BidxAsk is at 0.05 increments.
Why am I not able to place a limit order at say 0.27, does it have to be at 0.25 or 0.3? Thanks!