This is the second part of an occasional series where we discuss specifics with other experts in the industry. My former colleague Dominic Salvino from Group One Trading is not only the VIX options specialist on the CBOE but was on the committee that helped develop VIX products. I had a few questions for Dominic from the previous discussion. Namely, how would one consider VXX versus the VIX futures and also about the possibility of bullying the SPX options markets to manipulate VIX futures prints. Here’s what he had to say:
Let’s start with your second question first. The new product committee spent a LOT of time considering the possibility of market manipulation on the settlement of the vix contracts. Any cash product faces that risk and has to be settled intelligently to minimize such behavior. The basic strategy adopted by the committee and the CBOE was to open the morning print to all comers. Everyone is allowed to send orders into the open with little to no restrictions. By preventing anyone from having a favored position (e.g. market maker, specialist, broker-dealer, etc), we felt that the cost of creating an artificial print would be prohibitive. Currently, anywhere from 200,000 – 500,000 options go up on that print. Moving the settlement price by any significant amount would cost millions and perhaps tens of millions of dollars. While the CBOE does see large players in the opening print,regulatory oversight has always found the trades to be legitimate hedging and trading strategies rather than manipulation.
The VXX is obviously highly correlated with the two front month VIX futures that comprise it. The largest difference between trading in the VXX and the VIX futures is that holding a VXX position implicitly commits you to a particular rolling strategy in the VIX futures. If you want to roll your volatility future position daily to maintain a 30d average maturity, then the VXX is a very cost effective way to do that. Probably a more significant practical difference for your readers, however, is that the VIX futures are FUTURES. I.e. they are supervised by the CFTC and require a futures account at your brokerage firm to trade and hold. The VXX is a security and will sit in a more common security account governed by the SEC. It is generally harder and certainly less common to qualify for and actually have a futures account.
If you are interested reading more about this, Dan wrote a post in February that explored some of the consequences of VIX products on contango in the futures.