At this point, you should have a solid understanding of the VIX futures markets. VIX option prices are directly related to the corresponding VIX futures contracts. If you have a strong interest in VIX options and skipped directly to this chapter without reading Chapter 3, please back up a few pages. There are some important characteristics that the VIX futures and VIX options share—specifically, anticipatory pricing and the settlement process for each. A solid understanding of the information in Chapter 3 is essential before moving forward with this chapter.
Index options based on the CBOE Volatility Index were introduced on February 24, 2006. Less than a year later, the Super Bowl of Indexing Conference named VIX index options the most Innovative Index Derivative Product of 2006. The introduction of VIX options came about two years after VIX futures started trading at the CFE, but their popularity, based on volume, has surpassed the futures contracts. Institutions have found that at times VIX options offer the ability to hedge an equity portfolio better than other index option products, even products that directly trade based on a portfolio's benchmark index. This use of VIX options as a cheap hedging vehicle has led to the quick growth in trading volume.
As mentioned, acceptance of VIX options by traders, investors, and portfolio managers as a trading and hedging vehicle has caught on quickly over the course of just four years. Figure 4.1 displays the open ...