VIX options explained: what they track and why futures traders watch

Contents

1. What does the VIX volatility index actually measure?
2. How are the VIX index, VIX futures and VIX options different?
3. Why do VIX futures trade above or below the spot index?
4. How do VIX options settle, and how is that different from stock options?
5. How do you split a backtest by VIX regime?
6. How should volatility change your stops and position size?
7. Does a high VIX tell you where the market goes next?
8. Frequently asked questions
9. References

VIX options are cash-settled, European-style options on the Cboe Volatility Index, which measures the 30-day volatility implied by S&P 500 option prices. Each VIX option takes its price from the VIX futures contract that expires on the same date, not from the spot index. Futures traders watch the VIX to estimate how wide coming price swings may be.

What does the VIX volatility index actually measure?

The VIX measures how much movement option traders expect in the S&P 500 over the next 30 days. It says nothing about the direction of that movement. Think of it as a wind forecast for sailors. It tells you how rough the water will be. It does not tell you which way the waves will push the boat.

The VIX is a number that Cboe calculates from the prices of S&P 500 index options (SPX options), quoted as an annualized percentage. Implied volatility is the size of future price moves that option prices are paying for, read backwards from those prices. When traders pay more for protection, implied volatility rises and the VIX goes up.

A rough way to turn the VIX into a daily figure is to divide it by about 16. The 16 comes from the square root of roughly 252 trading days in a year. A VIX of 20 then means option prices assume a typical one-day S&P 500 move of about 1.25 percent. This is an expectation built into prices, not a promise about tomorrow.

How are the VIX index, VIX futures and VIX options different?

Only the futures and options can be traded. The index itself is a calculation that no one can buy or sell. This matters because many traders look at the spot VIX on a chart and then expect a VIX option to behave like an option on that number. It does not.

	VIX index	VIX futures (VX)	VIX options
What it is	A calculated value from SPX option prices	A futures contract on the VIX value at a future date	Options that settle to the VIX value at expiry
Where it is listed	Published by Cboe	Cboe Futures Exchange (CFE)	Cboe Options Exchange
Tradable?	No	Yes	Yes
Size	Not applicable	A thousand dollars per index point	$100 per index point
What drives its price day to day	Current SPX option prices	Expected VIX value at that contract's expiry	The VIX future with the same expiry

A smaller Mini VIX futures contract (VXM) also trades on CFE. Exchanges can change contract sizes, tick values and expiry rules, so check the current values on the Cboe and CFE contract pages before you use them. To turn a tick or point move into dollars for any futures contract, use the futures contract calculator.

Why do VIX futures trade above or below the spot index?

A VIX future prices the VIX expected at its own expiry date, so it usually differs from today's spot value. Contango is the state in which later VIX futures trade above earlier ones and above the spot index. It is common when markets are calm. Backwardation is the reverse state, in which near futures trade above later ones. It tends to appear when markets are under stress and the spot VIX has jumped.

As expiry gets closer, each future moves toward the value it will finally settle at. A trader who holds a VIX future in contango can therefore lose money even if the spot VIX does not move, because the future falls toward the lower spot level.

How do VIX options settle, and how is that different from stock options?

VIX options settle in cash, on a Wednesday morning, to a special value calculated from SPX option opening prices. Stock options usually settle into shares. The table shows the main differences.

	Typical US stock option	VIX option
Exercise style	American (can be exercised early)	European (exercise only at expiry)
Settlement	Delivery of shares	Cash
Price reference	The stock price	The VIX future with the same expiry
Standard monthly expiry	Third Friday of the month	The Wednesday 30 days before the third Friday of the next month, with holiday adjustments
Final value	Stock closing price	Special Opening Quotation (SOQ), calculated from SPX option opening prices on expiry morning

European-style means the option can only be exercised at expiry. Cash settlement means the holder receives the money value of the option instead of the underlying. Trading in the expiring VIX options stops on the business day before the settlement Wednesday. As a result, the final value is set at a time when the expiring options can no longer be traded, and it can differ from both the spot VIX and the last futures price of the day before.

VIX options also behave differently from equity options in how they are priced. The VIX often moves a large percentage in a few days, so the implied volatility of VIX options is usually high. Higher-strike VIX calls often carry richer implied volatility than lower strikes, because traders pay for protection against volatility spikes.

How do you split a backtest by VIX regime?

Label each trade with the VIX level known before the trade, then compare the results group by group. A volatility regime is a stretch of time in which volatility stays within a chosen range, such as low, normal or high. Splitting a futures backtest this way shows whether a strategy only works in one kind of market.

1. Get daily VIX closes for the same period as your futures data. Cboe publishes the history.
2. Use the previous day's close for each trading day. Using the same day's VIX close lets the label see the future.
3. Choose the regime edges from your own history. Splitting the history into three equal parts by VIX level (terciles) avoids picking round numbers that happen to flatter the result.
4. Tag every trade with the regime of its entry day.
5. Compare per regime: number of trades, average net trade after costs, maximum drawdown and the share of total profit.
6. Check the sample size. A regime with a few dozen trades describes a few market episodes, not a stable pattern.

In AlphaPrime (Valynox), the Performance Report shows individual trades and periodic performance. You can line those up against your VIX regime dates and see which periods carried the result.

How should volatility change your stops and position size?

When volatility rises, a stop measured in fixed points gets hit by ordinary noise more often. Widening the stop keeps it outside normal swings. Cutting the size keeps the money at risk per trade the same. A stop that suits a quiet week can sit inside the normal range of a stressed week.

Many traders scale the stop distance to recent price ranges with the ATR (Average True Range) indicator, which follows the volatility of the contract you trade. The VIX describes expectations for the S&P 500 as a whole. ATR measures what your own contract actually did on your own bars. Then they size the position so the dollar risk stays fixed:

Contracts = account risk ÷ (stop distance in points × point value)

Here, account risk is the money you accept to lose on one trade. Stop distance is how many points away the stop sits. Point value is what one full point of price movement is worth for one contract. The position size calculator does this arithmetic for any contract.

Test the sizing rule in the backtest itself. A strategy that only looked good because it traded full size through high-volatility weeks will show a very different drawdown once its size shrinks in those weeks. With the same fees and slippage fixed in AlphaPrime backtesting, a full-size run and a run that shrinks in high-volatility weeks differ only in the sizing rule.

Does a high VIX tell you where the market goes next?

No. The VIX measures expected movement, not direction. On the same day, the VIX often rises when the S&P 500 falls, because traders buy protection during selloffs. That relationship describes what happens at the same moment. It does not forecast the next move. A high VIX can come before a sharp rebound as easily as before a further drop.

Before you add a VIX rule to a strategy, check these three points:

• The VIX describes the S&P 500. For gold, bonds or TAIEX futures, the volatility of that market is often a better guide. TAIFEX publishes a volatility index calculated from TAIEX options.
• A VIX filter is another parameter. If you try many thresholds on the same history and keep the best one, the result is inflated. Research on backtest overfitting shows that when many parameter combinations are tried on the same history, the best-performing one overstates what you can expect later (Bailey, Borwein, López de Prado and Zhu, 2014).
• Test the filter on unseen data. Choose the threshold on one period and judge it on the next, as in walk-forward analysis. AlphaPrime's strategy validation includes walk-forward analysis and thresholds you set yourself.

What this means if you use AlphaPrime: build and validate the futures strategy as usual, then split its trades by prior-day VIX regime to see which market conditions carried the result. Treat any VIX-based rule you add as one more parameter that must pass validation on data it has not seen.

Frequently asked questions

Can you buy the VIX index directly?

No. The VIX is a calculated value, not a tradable asset. To take a position on volatility, traders use VIX futures on the Cboe Futures Exchange or VIX options on the Cboe Options Exchange. Both follow the expected VIX value at their own expiry date, not today's spot value.

Why does my VIX option not move with the spot VIX?

A VIX option follows the VIX future that expires on the same date. That future prices the VIX expected at expiry, which can be well above or below today's spot value. When the spot VIX jumps, a future months away often moves much less, and so does its option.

When do VIX options expire?

Standard monthly VIX options settle on the Wednesday that is 30 days before the third Friday of the following month, with adjustments around holidays. Trading in the expiring options ends the business day before. The final value is the Special Opening Quotation, calculated from SPX option opening prices that Wednesday morning.

What VIX level counts as high?

There is no fixed line that works for every strategy. A practical method is to rank the VIX closes in your own test period and split them into three equal groups. That way, low, normal and high match the history you actually tested.

Does a high VIX mean the market will fall?

No. The VIX often rises while the S&P 500 falls, but that happens at the same time and is not a forecast. A high VIX means larger moves are expected in either direction. Use it to adjust stop width and position size, not to choose long or short.

References

• Bailey, D. H., Borwein, J., López de Prado, M., & Zhu, Q. J. (2014). Pseudo-Mathematics and Financial Charlatanism: The Effects of Backtest Overfitting on Out-of-Sample Performance. Notices of the American Mathematical Society, 61(5), 458–471.