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Options with negative premium???


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I was looking for something else when I stumbled across this bizarre phenomenon. Basically, put options on the VIX or the CBOE volatility index trade at a negative premium.

 

For example, if you look at the January 22.50 strike price puts, they trade at $2.60 while the index is currently at 18.42. So if the index stays flat until next Friday, you will make $1.48 by buying these puts. I repeat, you are buying, you are not writing these puts or creating a liability! If you go to further dated in the money put options the gap gets even bigger.

 

What is the deal here? I know that the majority out there is fearful and likely expecting a return of volatility after having experienced a VIX in the 70's and 80's during the crisis, but this is out of whack. Also, the VIX was trading between 10 and 15 from 1992 to 1996 and from 2003 to 2007.

 

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options on the VIX are european style, so you can only exercise them on the expiration date. You cannot buy the VIX, only VIX futures, so basically you can only arbitrage the puts with the future expiring on the same date. It looks like the January VIX future is trading at 20.25

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Funny I ran across just that myself yesterday I was looking for a hedge and thought of the Vix and then started to look at the options and saw the same phenomenon. I purchaed VXX which is an ETF that trade off the the VIX at the close  today I frankly feel that the mkt is about to get a little bumpy

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I was looking for something else when I stumbled across this bizarre phenomenon. Basically, put options on the VIX or the CBOE volatility index trade at a negative premium.

 

For example, if you look at the January 22.50 strike price puts, they trade at $2.60 while the index is currently at 18.42. So if the index stays flat until next Friday, you will make $1.48 by buying these puts. I repeat, you are buying, you are not writing these puts or creating a liability! If you go to further dated in the money put options the gap gets even bigger.

 

What is the deal here? I know that the majority out there is fearful and likely expecting a return of volatility after having experienced a VIX in the 70's and 80's during the crisis, but this is out of whack. Also, the VIX was trading between 10 and 15 from 1992 to 1996 and from 2003 to 2007.

 

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I think there is an explanation for this - Options on VIX pay out on actual observed volatility for a given month, same with futures (I'm 95% sure of this).  This actual observed volatility for a month can be different that current implied vol, especially if a month is half over (in which case quoted VIX is only forward-looking, while option VIX payouts based on future 1/2 month and historical 1/2 month).

 

I'm not positive, but I think that is the explanation.

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Here is what I have found explaining the "phenomenon":

 

https://us.etrade.com/e/t/invest/mfstatic?gxml=volindexoptions.html&rightrail=disable&skinname=none

 

So, the quoted VIX (spot VIX) is totally useless to compare with the options. It is not the underlying for the options. It is all based on the VIX futures. Thanks T-Bone 1 and Watsa_is_a_randian_hero for the help.

 

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