A. There’s an inverse correlation between the market volatility (VIX) and the stock market - when the market drops, fear and uncertainty tend to rise. However, you can’t directly buy the VIX because it’s a reference rate - an index made up of the implied volatilities of a basket of short-term options on the S&P 500 ($SPX), normalized to a 30-day constant maturity.
But there are ways to sell and buy volatility exposure, as discussed below:
1. VIX Futures
VIX futures (/VX) are simply the market’s anticipation of where the VIX will be at monthly points in the future. VIX futures are cash settled, with a final settlement value equal to $1,000 times the settlement price. So, if you buy a VIX futures contract for 15 and it drops to 14, you’ll be down $1,000. The minimum tick size is 0.05, which represents $50. VIX futures settle to a settlement reference index under the ticker symbol VRO. But futures aren’t for everyone. They involve leverage, and not all accounts allow the trading of futures. Plus, if you’re looking to buy and hold volatility, the value of your investment might erode over time.
2. Volatility ETFs/ETNs
If you’re looking for a buy-and-hold strategy and you either can’t trade futures or don’t wish to trade futures, there are a number of exchange-traded products such as volatility ETFs and ETNs that attempt to mirror the performance of the VIX.
These products trade like stocks insofar as they can be bought and sold on exchanges and are generally available for most account types. They don’t hold securities, but rather use derivatives to attempt to track VIX performance. And although their aim is to mirror the VIX, they don’t always hit the mark. Because most of them use VIX futures, they’re subject to the same contango loss as VIX futures, plus a number of administrative and transaction costs.
3. VIX Options
VIX options are much like standard equity options, with a few key differences.
First, they’re European-style options, which means they can be exercised only at expiration (as opposed to standard equity options, which may be exercised on any business day up to and including expiration day).
Plus, unlike standard options that are physically settled into shares of the underlying stock, VIX options are cash settled (at $100 times the intrinsic value at expiration), with in-the-money options settling to the same settlement reference (ticker symbol VRO) as VIX futures.
Finally, perhaps the most important aspect of VIX options is that they’re based not on the VIX itself, but rather on VIX futures.