CBOE Volatility Index® (VIX®) options began trading on the Chicago Board Options Exchange on 24th February, 2006.
Traders who do not fully understand the relationship between the VIX and VIX option prices were often frustrated when the option prices do not seem to follow the movement of the VIX.
After a spike in the level of the VIX, VIX options often appears to be trading at a discount. The reasons for this behavior are because VIX options are european style options and also because the VIX is a mean-reverting index.
Firstly, because VIX options are european style options, they can only be exercised on expiration date, and so their valuation is based on the expected, or forward, value of the VIX on expiration date, rather than the current, or "spot" VIX value.
Secondly, the VIX is a mean-reverting index. Often, spikes in the VIX do not last and usually drop back to moderate levels soon after. So, unless the expiration date is very near, the market will take into account the mean-reverting nature of the VIX when estimating the forward VIX. Hence, VIX calls seem heavily discounted whenever the VIX spikes.
To get a better sense how the market is estimating the forward VIX, options traders can look at the VIX futures price.
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