The VIX is the most quoted volatility number in the world, and you cannot buy it. What trades are VIX futures and options on them, and they surprise almost everyone the first time: a fund built to follow the VIX can lose most of its value in a year that the VIX ends where it started.
A two-line recap from Module 12: the VIX is the 30-day implied volatility of the S&P 500, worked out from SPX option prices and quoted in vol points. It is a calculation, not an asset, so nothing you can hold tracks it one for one.
A future on a number you cannot own
A stock future is tied to the stock by carry, as Module 2 showed: hold the shares and the future cannot stray from spot plus interest minus dividends. The VIX has no shares to hold. So a VIX future is simply today's price for the VIX level on one future morning, its settlement date, when the two must meet. Each monthly contract settles on a Wednesday morning to a special opening value of the VIX, calculated from that morning's opening SPX option prices, and pays $1,000 per VIX point. Line the contracts up by date and you have the VIX futures curve.
Contango and backwardation
Here is a made-up but typical calm-market curve.
| Contract | Price |
|---|---|
| VIX (spot) | 15.0 |
| 1-month future | 16.8 |
| 2-month future | 18.1 |
| 4-month future | 19.4 |
Futures above spot, rising with time, is called contango, the normal state. The VIX tends to drift back toward its long-run average, a habit called mean reversion, so from a low level the market expects it to rise. It also spends most days quiet and then jumps hard, so a later future prices the chance of a spike before it settles, plus a premium for whoever sells that protection.
In a selloff the curve flips. With the VIX at 35, the 1-month future might trade at 30 and a later one at 26: the market expects the panic to fade. A curve that falls with time is called backwardation. The same logic means futures move less than the index. A jump from 15 to 21 might lift the 1-month future from 16.8 to about 19.5 and the 4-month only from 19.4 to about 20.5.
Convergence and roll yield
At settlement the future and the index are the same number. Suppose the VIX sits at 15 for a month. The 1-month future has to fall from 16.8 to meet it: 1.8 points, $1,800 a contract, 10.7%, in a month when the VIX did nothing. The gain or loss from a future sliding toward spot is called roll yield, and in contango it is negative for the buyer.
Exchange-traded products that track short-term VIX futures hold the first two months and each day sell some of the nearer contract to buy the later one, keeping about 30 days to settlement. In contango that is selling the cheaper contract and buying the dearer one, every day. Lose about 10% a month and a year of calm leaves about a quarter of the money. In a spike the curve inverts and the roll pays, which is why these products are hedges held for days, not investments held for years.
VIX options are priced off the future
A VIX option settles to the same Wednesday value as the future for its month, so its real underlying is that future, and put-call parity holds against it. VIX options are European, settle in cash and pay $100 per point; Module 13 went through how morning settlement works.
Pricing off the index is the classic mistake. With the VIX at 15 and the 1-month future at 16.8, a 1-month 18 call looks 3 points out of the money, but against its real underlying it is only 1.2 points out. At 90% volatility with 30 days left it is worth about $1.25; priced off 15 it would be about $0.59. Delta works the same way: a 3-point jump in the index that lifts the future 1.5 points moves the call as if the VIX had risen 1.5.
The axis is the VIX future's value in points (read the dollar signs as points); each point is $100 a contract. The call is priced off the future at 90% volatility. Drag volatility down to 40 and the call is worth almost nothing: most of what you pay for is vol of vol.
The 20 call on a future at 16 costs about $0.49, $49 a contract. It pays only above 20.49 at settlement, but past that every point is $100, and a spike can carry the VIX a long way.
Vol of vol
The volatility of the VIX itself, called vol of vol, is several times the volatility of the index it measures: VIX options often imply somewhere between 80% and 120%, because the VIX can double in a week. The VIX smile also leans the opposite way to a stock's. Upside calls carry the higher implied volatility, because the VIX jumps up, not down.
The range one month out for a VIX future at 16 (read the dollar labels as VIX points). One standard deviation runs from about 12.4 to 20.7. Drag volatility down to 17, a calm index level, to see how narrow a stock index's own range is by comparison.
One standard deviation for the month runs from about 12.4 to 20.7, more than a quarter either way, against under 5% for the index itself at 17% volatility.
The maths: what a VIX future should cost
A 1-month VIX future pays the 30-day volatility the index will be priced at a month from now. Today's index options already imply a volatility for that window, the forward volatility. From variance-based vols like the VIX, v1 over T1 and v2 over T2: forward variance = (v2² × T2 - v1² × T1) / (T2 - T1). With 16 for 30 days and 18 for 60 days: (324 × 60 - 256 × 30) / 30 = (19,440 - 7,680) / 30 = 392, and the square root of 392 is 19.8.
The future should trade near 19.8, and a little under. It settles on the VIX, the square root of variance, and when a number moves around, the average of its square root is smaller than the square root of its average. The more vol of vol, the bigger that gap, called the convexity adjustment.
Your turn
Open Market Overview, click the VIX tab and read the level every future settles to. Then compare SPY's at-the-money IV on the monthly and a later expiration to see which way the index curve runs today.