I’m going to assume you’re reading this because you’re interested in buying a put option on the VIX. Maybe you’ve come across a news article about the VIX and you’re curious about buying a put option. Or, maybe you’re a professional investor who wants to learn more about options. No matter what your reasons are, I want to welcome you to this wonderful world of volatility.
The VIX is a benchmark index for implied volatility as measured in the S&P 500 stock market. The VIX is frequently used as a benchmark for index option trading because it approximates the volatility that would be seen if you were to actually enter into a plain-vanilla option contract. Buying a put option on the VIX gives you the right to buy the S&P 500 at the strike price of the option you just bought (plus a little more).
Let’s take a quick look at how the price of a put option on the VIX relates to the price of the underlying S&P 500 index:
How Volatile Is The S&P 500 Index?
The short answer: very! We’ll come back to that. For now, let’s just say that the S&P 500 is one of the most popular stock market indices. It’s a broad measure of the performance of the equity market as a whole, and it’s frequently used as a benchmark for equity option pricing. So, you can bet that there’s a lot of market interest in the S&P 500 when it comes to options.
The volatility of the S&P 500 index is determined by taking a look at its historical performance during major market corrections. In other words, if you look at the price history of the S&P 500 during a major bear market, you’ll see very high volatility. During some of those down periods, the S&P 500 dropped by nearly 30% or more in value. For example, back in 2019, the S&P 500 fell by 26% during one particular quarter while in the same year, the S&P 500 only fell 5% in the other three quarters. During 2019 alone, there were 20% corrections in the S&P 500 for every day of the quarter—a very volatile annualized rate!
Where Can I Trade The VIX?
One of the great things about the VIX is that it’s very accessible to traders. You can use US-based online brokers to easily put on sells/buys of the VIX, and you’ll find the prices are generally very good (if a little steeper than you’d find if you traded the S&P 500 directly). The spreads for VIX trades are generally tighter than you’d find for S&P 500 options—which means it’s more affordable to buy or sell lots of the VIX when compared to lots of the S&P 500.
The VIX is also available for both online and offline trading. You can find many places where you can buy and sell the VIX, including dark pools like NASDAQ and CBOE—as well as major stock exchange markets like the NYSE and the London Stock Exchange.
Why Should I Buy A Put On The VIX?
The main purpose of buying a put option on the VIX is to speculate on the direction of the S&P 500. As mentioned above, the volatility of the S&P 500 is very high during major market corrections. So, if you think that the S&P 500 will decline in value, you might want to think about buying a put option so you can profit from the anticipated decline. Of course, you can put on a sell option on the VIX if you think the S&P 500 will rise in value. Just remember: with options, you’re always speculating. It’s always a matter of opinion and it’s never a sure thing.
How Do I Buy A Put On The VIX?
In general, you would want to buy the S&P 500 call version of the put option (the opposite of the one we just described). Short-selling (buying) puts is a very dangerous game to play, particularly with a highly volatile stock like the S&P 500. Why? Imagine this scenario. You think the S&P 500 will decline in value, so you short the call option. The price of the S&P 500 then continues to fall, and at some point, you’ll have to cover your short. In other words, you’ll need to buy the S&P 500 at the current price to keep the contract in good standing. But you’ve already made money in the market by selling the call; in fact, you made a small fortune because the S&P 500 fell sharply. Now you’ve got to buy the stock back at a much higher price than you sold it for. That’s a losing proposition. Remember: options are always a matter of opinion and they’re never a sure thing. So, if you want to be sure that you’re going to win, it’s usually best to avoid putting on sell options on the VIX.
The safest bet when buying options is to use leverage. This means borrowing money to access the market. When you use leverage, your exposure to risk is dramatically reduced because you’re not putting up all your own money. For example, if you’re using margin, the lender will charge you a percentage of the price of the contract. Margin is always a good idea because it gives you a little breathing room if the market moves against you. But even with margin, you’re going to lose some money if the market moves too far against you.
What About The Risks?
One of the major risks associated with buying options is that they’re not suitable for all investors. It’s very risky to put on large positions (ie. buy or sell more than you can afford to lose) in the stock market because you never know when the next big move is going to come. Options are only suitable for more experienced investors who know how to use them properly and understand the risks involved. Some brokers don’t allow option contracts to be bought by individuals who aren’t accredited; therefore, it’s always best to know your limits before entering the market. In addition, as mentioned above, options are always a matter of opinion and they’re never a sure thing. So, even if you use proper techniques and stay within your limits, you may still lose money.