How to Buy the VIX Step-by-Step (Trade the VIX with Options)

Rebel Hub Education

by

Justin Nugent

November 13, 2023
at 1:36 PM

Whether you’re looking to hedge a long portfolio, or weary of a looming market surprise, it’s important to know how to buy the VIX, and how to trade the VIX with options. The VIX, also known as the stock market “fear gauge,” is a measure of how much the S&P 500 is predicted to move over a given period of time. In this article, we’ll walk you through the process of buying the VIX step-by-step, and give you the lowdown on trading VIX options. First, you’ll want to know what exactly the VIX is.

What is the VIX?

The VIX, otherwise known as the CBOE Volatility Index, is a ticker that tracks market volatility. The VIX is a real-time index derived from the price changes in S&P 500 index options with near-term expiration dates. Like the VXX, the VIX is a 30-day measurement. When the VIX is running higher, market participants expect bigger moves in the market. When the VIX is running lower, market participants expect smaller moves in the market.

As a rule of thumb, the VIX operates in deviations of 16. A VIX of 16 means the market expects daily ~1% moves in the S&P 500 over the 30-day period. A VIX at 32 means the market expects daily ~2% moves in the S&P 500 over the 30-day period. Important to note: The VIX has an impact on option prices. When the VIX is running higher, it usually means the extrinsic value of options will be higher, meaning options can get pricier.

“At a 16 VIX, that means the S&P has to move 1% per day, every single day. When you get to 32 — now you need a 2% move, every single day.”
Pete Najarian

How to Buy the VIX

Step 1: Choose the Right Brokerage

Buying the VIX outright isn’t all that difficult, but the first step is crucial. You must choose a brokerage that allows you to trade the VIX. For instance, Robinhood and Webull do not allow you to trade the VIX. Not options, not shares, not anything.

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A screenshot from WeBull’s VIX quote — note the option to trade is replaced with an unclickable “Not Tradable” button.

On the other hand, Thinkorswim and Interactive Brokers do allow you to trade the VIX — both options and stock. If you can’t trade the VIX directly, you can trade a few VIX lookalikes, but we’ll get into that in a moment.

Step 2: Understand the Risks of Trading the VIX

It goes without saying, but investing in anything carries risk. It just so happens that the VIX carries a little extra risk. Because it’s based on S&P 500 index options, the VIX can be a fast moving index. For instance, between February 14th and March 20th, the VIX moved from 13.68 to 66.04 — an increase of 382.75% in just over a month. While this is an extreme example, a quick glance at the VIX chart shows dozens of instances where the VIX quickly doubled (or rapidly fell).

The VIX chart extending back to April of 2004. Source: Google

This is part of why trading the VIX with options is so popular — options prevail when a quick move is made in the target ticker. However, with trading options comes a new risk — liquidity risk. The VIX is the most commonly traded volatility instrument, but you’ll still find that certain expirations and certain strikes carry very low liquidity, meaning it can be difficult to buy or sell them at a fair price.

A screenshot from Thinkorswim’s VIX options chain. Note the vast difference in open interest between some of the strikes.

In other words, you may make a great prediction, but get trapped in the contract until you agree to find someone who’s willing to buy it!

Once you understand the risks involved, it’s time to move onto the third step:

Step 3: Buying the VIX

This one is straightforward. Because the VIX sometimes operates on low liquidity, the most common approach to buying the VIX is to use a limit order, rather than a market order. A limit order identifies the maximum price you want to pay in order to purchase the VIX. The order will not execute above the limit price you set. A market price will execute immediately, however it won’t always be at a price you feel is favorable. In instances where the VIX is moving fast and you feel you must get in by any means necessary, you can use a market order, but there is added risk here as described above.

While VIX is the most common stock market volatility index, there are several ETFs and ETNs that track market volatility as well.

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Stock Market Volatility ETFs and ETNs

iPath S&P 500 VIX Short-Term Futures ETN (VXX): This ETN (exchange traded note) tracks the S&P 500 VIX Short-Term Futures Index, which measures the expected volatility of the S&P 500 over the next 30 days. While it may sound the same as the VIX, it’s actually a different product.

The VXX is based on VIX futures, while the VIX is based on S&P 500 index options. Because futures need to be “rolled,” you’ll notice that the VXX experiences a level of time decay that the VIX does not. For that reason, the VXX is only for short-term trading.

Still, for certain situations, the VXX is an excellent tool to trade market volatility. Aside from the VIX, the VXX typically has the highest liquidity of the volatility ETFs and ETNs. Because the VIX is an index rather than an ETF, it may not be available on all trading platforms. When the VIX can’t be reached, you may find yourself reaching for the VXX.

Simplify Volatility Premium ETF (SVOL): Like the VXX, this ETF tracks the S&P 500 VIX Short-Term Futures Index, which measures the expected volatility of the S&P 500 over the next 30 days. This is, generally speaking, a lower liquidity ETF than the VXX.

iPath S&P 500 VIX Mid-Term Futures ETN (VXZ): This ETN tracks the S&P 500 VIX Mid-Term Futures Index, which measures the expected volatility of the S&P 500 over the next 60 days.

Short VIX Short-Term Futures ETF (SVXY): This ETF is designed to go down in value when the VIX goes up. In other words, it’s a bet against stock market volatility. This is how to short the VIX, without having to actually short the VIX. It is a short-term investment that should not be held for long periods of time.

iShares MSCI EAFE Min Vol Factor ETF (EFAV): This lesser known ETF tracks the MSCI EAFE Minimum Volatility Index, which measures the performance of a basket of low-volatility stocks in the EAFE (Europe, Australasia, and Far East) region. This is relatively niche, and as such, operates on pretty low liquidity. Options traders should beware of making an option trade in a low liquidity ticker because it may be difficult to open and close the contract at a reasonable price.

SPDR SSGA US Small Cap Low Volatility Index ETF (SMLV): This ETF tracks the SSGA US Small Cap Low Volatility Index, which measures the performance of a basket of low-volatility stocks in the US small-cap market. It’s like the EFAV, except it measures certain US stocks rather than international ones.

Okay, you now understand the different tools you can use to buy the VIX. However, we feel there’s a better way to trade the VIX than simply buying shares outright.

Let us show you how to find Unusual Options Activity

Everything you’ve ever wanted to know about Unusual Options Activity—in one convenient insider’s guide.

How to Trade the VIX with Options

Above, we identified why the VIX is an appetizing option for options traders. The VIX is a fast-paced index prone to big spikes and falls. Additionally, because the VIX is a relatively low priced instrument, VIX options are typically somewhat cheap.

Most importantly, options allow you to take a short VIX stance without having to actually short the VIX. It makes sense that we identify so many institutional whales purchasing VIX options in our unusual options activity service. There’s even one legendary VIX trader, known only as 50 Cent, who is known for purchasing massive swaths of far OTM VIX options.

In the trade above, with the VIX trading at 30.05, 100,000 contracts were purchased expiring June 21st at the 15 strike. These contracts were bought for just $0.09 each — a total cost of $900k. On June 21st, the VIX had fallen to 13.20, boosting the value of these options to $1.80 each, and the value of the trade to a cool $18 million dollars.

But before you can start trading like 50, you’ll have to pick up the basics.

Step 1: Get Familiar With the Basics of Options

To trade VIX options like a pro, you need to understand the basics. Wrap your head around call and put options, strike prices, expiration dates, and option pricing models. Learn what the difference is between intrinsic and extrinsic value is. It might sound daunting, but trust me, it’s well worth it. Market Rebellion has a cornucopia of resources to help you understand those terms. Use this glossary to brush up.

Step 2: Select the Perfect VIX Option

If you’re already an options aficionado, it’s time to pick the right VIX option contract. For this, it often helps to have a strategy. Many traders use trends to help them decide what the right strike price should be for their VIX prediction.

For instance, in the 15 strike trade from October 2022 shown above, the user bought put options (a bet against the VIX) when the VIX was above average — and they centered their price target around a VIX value that had been reached – if not surpassed, during 10 of the prior 12 years. (As an added bonus fact, the average VIX value since its inception is 19.54).

The buyer also gave themselves plenty of time to be right — in this case, about 8 months. That means if at any point the VIX fell to one of those common “year lows” below 15 shown above, they could have booked a profit on their $0.09 investment. But there’s more to picking a strike than just analyzing trends. You’ll want to stay up on specific day-to-day market events, including inflation reports, economic data, FOMC meetings, and even big earnings. Anything that could shake up the stock market.

Step 3: Hone Your VIX Trading Strategy

Every successful trader needs a consistent strategy. At Market Rebellion, we refer to it as your “trading discipline” — it’s a set of rules you make for yourself and stick to. That might be, “I will buy this option, ‘set it and forget it,’ trusting in my initial trade thesis, and holding until the end. Or it might be, “If my option doubles in value, I will take some off the table.”

Making a trading strategy also means understanding your risk tolerance. For some traders, that might be only using 1% of your total account value on any particular trade. Maybe it’s 10%. Whatever it is, set a rule for yourself and stick to it. (And don’t make it 100% — YOLOing is for gamblers, not traders.)

In short, consider your risk tolerance, time horizon, and market outlook. Then decide whether you’ll be buying calls or puts, using spreads or straddles, or something else. Think of it like putting together the pieces of a puzzle.

Step 4: Execute Your VIX Trade

Even if you select a high-liquidity option contract, we typically prefer limit orders to market orders when trading VIX options. It’s just safer. A quick spike or dump in prices can come at any moment, and even the most liquid of VIX contracts can be the unfortunate bearer of a wide bid/ask spread. By selecting a limit order, you’re drawing a line in the sand, saying, “This is my definitive maximum I’ll buy for,” or “This is my definitive minimum I’ll sell for,” putting you in charge of your trading destiny.

Once you’ve set a limit price you feel comfortable with, and you’ve picked a strike, expiration, and strategy that’s suitable for you, you can press that execute button, and trade the VIX.

Our Favorite VIX Trading Strategy: How to Trade the VIX Like a Pro

So, are you ready to buy the VIX, or take on the thrilling world of trading VIX options? With a bit of knowledge, some courage, and a dash of strategy, you can ride the ups and downs of market volatility like a pro. However, your strategy isn’t complete yet.

Our favorite strategy of all time to trade the VIX is to follow the smart money. We use a combination of institution-level algorithms and professional trader oversight to scan through every option trade made throughout the day, hunting for the ones that stand out as unusual.

When we see trades like the one we showed above, where a buyer is staking hundreds of thousands on a seemingly outlandish outcome, we let them do the work for us — following their trade, riding on their (likely institutional) coattails. Recently, we identified a similarly massive 100,000 contract trade in the VIX, with a much closer expiration date — but we think the strike and direction would surprise most traders.

Find out what we’re seeing in the world of unusual options activity — in tickers across the market, from the VIX, to AAPL, to little-known stocks, with our Unusual Options Activity service. Try a month of trades below.

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