VIX: A Visual Explanation

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1 What is the VIX? Vola/lity is a highly important metric in trading and directly Impacts op/on pricing. The Vola/lity Index or VIX is used to gauge this overall market vola/lity. 1 of 10

2 In 2008, when the market crashed, the VIX spiked The VIX is some/mes called the fear index since it represents expecta/ons of the future vola/lity of the S&P 500 over the next 30- days. 2 of 10

3 More recently, when the S&P dropped 10%, the VIX doubled Interpre/ng VIX: A VIX of 25 means the market is pricing op/ons to expect a large 30- day move in the S&P 500 (which is annualized to a 25% move). 3 of 10

4 Calcula/ng expected moves We can use the VIX to calculate the 30- day expected move of the S&P 500. As an example, with the S&P 500 at 2065 and the VIX at 13.47, the 30- day, 1 standard devia/on expected move is ± of 10

5 Actual move was less than expected move Actual move was more than expected move Implied (expected) vs actual moves: The op/on market may price in a large expected move in a stock, but rarely does it move that far. As long as the actual move stays within the expected (implied) move, the seller keeps the premium paid by the buyer of the op/on. Here we demonstrate how the actual move is usually less than the expected move. 5 of 10

6 With higher VIX, comes greater expectation of a large move in the market Low and high VIX: A higher VIX implies a greater expecta/on of a large move in the market - - yet, as we previously showed, the market usually overstates the move (i.e. the actual is less than the expected move). Therefore, the largest amount of premium in the op/on, is when the VIX (implied vola/lity) is high. 6 of 10

7 Op/on premium and VIX The higher the VIX, the greater the premium built into the op/on price. As an example, we show the theore/cal op/on prices for the S&P 500 at 2050 (with a 2050 strike and 30 days un/l expira/on). VIX: A Visual Explanation VIX (Implied Volatility) Option Premium 5 $12 10 $24 15 $35 20 $47 25 $59 7 of 10

8 In a previous Market Measure* we demonstrated the profitability of buying versus selling op/on premium. We did this by backtes/ng the selling of a strangle in SPY (i.e. 84% probability of success) every 5 days. Results (at expiration) Buying Strangles Selling Strangles % of winners 17% 83% Average trade -$77 $77 Average winner $208 $131 Average loser -$131 -$208 Max win / loss $1100 / -$499 $499 / -$1100 Total P&L -$20,333 $20,333 * Premium: Why Selling it Works on Oct 23, of 10

9 In that same Market Measure* we also demonstrate selling premium (via strangles) when implied vola/lity is low versus high**. In that segment selling strangles in high VIX environments outperformed selling in low VIX environments by 65%. * Premium: Why Selling it Works on Oct 23, 2014 ** Low = Implied Volatility Rank below 35; High = Implied Volatility Rank above 35 9 of 10

10 Takeaways: VIX (implied vola/lity) is an important metric we use when trading the S&P 500 Selling outperforms buying premium Selling op/on premium in high VIX (implied vola/lity) environments outperforms selling in low VIX environments 10 of 10

11 DISCLAIMER: The purpose of this material is to demonstrate market trading techniques and strategies designed to give you the skills and confidence to manage your own investments. The risk of loss in trading securi/es, op/ons, futures and forex can be substan/al. You must consider all relevant risk factors, including your own personal financial situa/on, before trading. Op/ons involve risk and are not suitable for all investors. You are assuming the en/re risk of any and all trades placed in the stock market. Due to the /me- cri/cal nature of trading, the varying fees charged by brokerages, and the ac/vity of other market par/cipants, tastytrade cannot guarantee that similar trades you place will mirror the exact performance of the tastytrade porcolio. tastytrade is not a licensed financial advisor, registered investment advisor, registered broker- dealer or FINRA SIPC NFA- member firm. tastytrade does not provide investment or financial advice or make investment recommenda/ons. tastytrade is not in the business of transac/ng trades, nor does tastytrade agree to direct your commodity accounts or give trading advice tailored to your par/cular situa/on. Nothing contained in tastytrade s porcolio demonstra/on cons/tutes a solicita/on, recommenda/on, promo/on, or endorsement of any par/cular security, other investment product, transac/on or investment. BY USING THE TASTYTRADE WEB SITE AND ACCESSING THE TASTYTRADE MATERIALS, YOU AGREE, AT ALL TIMES, TO INDEMNIFY, DEFEND, AND HOLD TASTYTRADE (INCLUDING ANY OF ITS AFFILIATES, OR ITS RESPECTIVE SUCCESSORS AND ASSIGNS, OR ANY OF ITS RESPECTIVE OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, REPRESENTATIVES, LICENSORS, OPERATIONAL SERVICE PROVIDERS, ADVERTISERS, OR SUPPLIERS) HARMLESS FROM AND AGAINST ANY AND ALL CLAIMS, ACTIONS, DEMANDS, SUITS, LOSSES AND COSTS (INCLUDING ATTORNEYS FEES) RESULTING FROM TRADES YOU PLACE IN THE MARKET. TASTYTRADE SHALL NOT BE LIABLE FOR ANY LOSS OR DAMAGE, OF ANY KIND, DIRECT OR INDIRECT, IN CONNECTION WITH OR ARISING FROM USE OF EDUCATIONAL SERVICES PROVIDED AS PART OF THIS PORTFOLIO DEMONSTRATION.