The Expiration Of $VIX Futures and Options (16:20)

By Lawrence G. McMillan

This article was originally published in The Option Strategist Newsletter Volume 16, No. 20 on October 25, 2007. 

We have seen a renewed interest in how the $VIX settlement price is computed, as it pertains to expiring $VIX futures and $VIX options. Most of this interest has come from people who feel that they may have been “duped” by a somewhat biased settlement of $VIX. This is a false notion, fostered by the fact that $VIX has often “jumped” or “gapped” from its close on the last trading day (a Tuesday) to the morning settlement price (on Wednesday morning).

The CBOE Futures Exchange (CFE) posts an enormous amount of information at http://cfe.cboe.com. All of the procedural rules regarding expiration are posted here, as well as a large amount of data regarding the trading as the settlement process is transpiring.

Without going into a great amount of detail, these are the important points:
1) $VIX futures and options settle in an “a.m.” (Morning) settlement 30 days prior to the next $SPX option expiration. For example, $SPX December options expire on December 21st, the third Friday of the month. $VIX November futures and options expire 30 days prior to that – on November 21st.

The reason that $VIX settlement is 30 days prior to the next $SPX option expiration is that $VIX is computed using the “strips” of options of the two nearest $SPX expirations. Those strips are then weighted so that $VIX is a 30-day volatility. But, when one strip of $SPX options has exactly 30 days remaining until expiration, the $VIX calculation for that day only, involves only that 30- day strip of $SPX options. Hence, $VIX expiration was set for that day so that the market makers can arbitrage their positions with just one strip of $SPX options.
2) Not all $SPX options are used in determining the $VIX settlement price. The exact process is described via a link at the above URL, by clicking on “Volatility Index Futures Settlement.” Briefly, if an $SPX option of that expiration strip trades on the opening, that is the price used for the $VIX calculation; otherwise, the average of the bid and asked price of the option is used.

Some deeply out-of-the-money options may not be used, though: if a certain $SPX series trades, but then there is no bid after the trade, the option is not used in the $VIX calculation. Moreover, if two consecutive call strikes have no bid, then no calls with any higher strikes are used. Similarly, if two consecutive put strikes have no bid, then no puts with lower strikes are used.

The CFE has a lot of information regarding this process on their web page. Go to the above URL, and then click on “CBOE Volatility Index (VIX) Futures,” then click on “Settlement & HOSS SPX Information.” Scroll down to the bottom of that page, and you will see several items. We’ll refer to these as the “HOSS info.” The first item is “VIX Settlement Series.” On the day before expiration, the CFE shows you what $SPX options are likely to be involved in the expiration process. Moreover, on expiration Wednesday itself, the actual series are listed. In both lists, the pertinent options are highlighted in gray.
3) Also, in the “HOSS Info” is an entry entitled “HOSS Data/SPX Opening Order Imbalance Information.” That is where important information regarding the settlement series is posted on the morning of expiration day. Orders pertaining to VIX settlement must be entered by 9am Eastern time. Imbalances are then posted on the above link. Parties wanting to trade against the imbalances can then enter orders, and the information is constantly updated until the 9:30am (Eastern time) opening.

This information can be used by anyone, to gauge how the $VIX settlement might go. For example, if there are many options to buy, it is likely that the trades will all take place on the offering side of the options in question. That will likely raise the price of $VIX above its Tuesday night closing price.

At any time one can see the value of $VIX if all options in the calculation were to trade on the bid or on the offer. This information is broadcast by the CFE to all data vendors constantly. The bid side of $VIX is the symbol $VWB; the asked side of $VIX is the symbol $VWA. These can be quoted constantly, if one wishes, but on expiration morning, they can be a guide towards where $VIX might settle.

4) The $VIX Settlement price is broadcast as the symbol VRO. The symbol should be quoted as an index ($VRO on eSignal, for example). This symbol can be quoted at any time, but it only changes once per month – on expiration day of $VIX futures and options.

Summary

As a non-market maker, one may observe this process with interest, but as a practical matter, traders should normally close out their $VIX positions prior to the settlement, lest a nasty surprise gap in $VIX occurs, causing an open position to lose money. For example, if one were long $VIX Oct 19 calls, he might have thought they would expire in the money, but in fact, they expired worthless due to the bullish market on the Wednesday morning of settlement of $VIX.

This article was originally published in The Option Strategist Newsletter Volume 16, No. 20 on October 25, 2007.