How do you calculate profit, loss, and risk when trading VIX futures?
Last month we discussed the basic characteristics of the VIX futures contract traded on the CBOE (Chicago Board of Option Exchange), along with some of the challenges and advantages the product offers speculators. In this column, we to focus on the bottom line; how to calculate gains and losses, and an example of the risks and reward potential.
As a quick reminder, the VIX is an index that measures the expected volatility in the S&P 500. As a bullish trader, the biggest challenge (aside from the usual timing and direction) is the burden of erosion. Similar to the value of an option, the value of the VIX futures contract deteriorates as time passes in the absence of an uptick in volatility. Nonetheless, when the VIX does finally move higher it has a tendency to do it in an “all or nothing” fashion, thus for patient and disciplined traders there might be a great opportunity for upside potential in bullish VIX trades.