By Tom Jarck, VP, Proprietary Product Development, MIAX
In investor terms, volatility is the word often associated with the condition markets fear most: uncertainty.
There is a certain amount of volatility every day, exacerbated occasionally by dramatic events — like a global pandemic. When investors want to measure or protect themselves from volatility, they have traditionally turned to VIX, commonly referred to as the “fear gauge” — a term I do not necessarily agree with, because volatility more closely relates to uncertainty.
In the past, investors had no alternative to VIX options and futures for managing volatility exposures as measured by VIX levels. This was the case despite certain flaws that were often highlighted by many in the market community. More recently, a new index called SPIKES has come to light, and it also offers options and futures to hedge and/or speculate against future volatility expectations.
VIX and now SPIKES indices both measure volatility. They are both used as an implied forecast of the expected volatility in 30 days of (i) in the case of VIX, the actual S&P 500 Index itself, and (ii) in the case of SPIKES, the SPDR S&P 500 ETF (SPY), an ETF that tracks the performance of the S&P 500 Index. As a result, both volatility indices are effectively measuring the volatility of the 500 leading U.S. large-cap companies in the market, which covers approximately 80% of market capitalization.
A crucial difference between the two is that VIX prices are calculated from SPX options, while SPIKES prices come from the SPY options. SPX options are European style — meaning they cannot be exercised until the expiration date — whereas SPY options can be exercised any time from purchase to expiration date, also known as the American style. In addition, unlike the SPX index, which “leaks” dividends daily, the SPY ETF may pay dividends, typically quarterly.
The use of SPY options as inputs to the SPIKES calculation not only brings a high degree of accuracy from the tight bid/ask spreads, but also avoids any single-point failure because SPY options are listed on multiple regulated exchanges in the US.
Although one cannot buy or sell the actual SPIKES Index, there are options and futures available in the marketplace to gain or hedge exposure. The common strategies and uses of these derivatives can also be applied to SPIKES. For example, if one wants to hedge against future volatility moving higher, a market participant may buy a future, call or call spread, or sell a put, among other strategies. The shorter dated futures will typically have the greatest reactions to the changes in volatility and movement in the underlying ETF, SPY.
Traders and investors now have a choice and a way to diversify exposures, adding another product to the volatility product ecosystem. To aid the professional trading community, MIAX, the exchange on which SPIKES options trade, outlined a strategy known as “Combo Linked to Future.” This strategy enables the reallocation of delta risk and cross-clearing exposures between related products, such as SPIKES or VIX futures against SPIKES combos.
The SPIKES Index is calculated and disseminated by MIAX in partnership with T3 Index. SPIKES options trade on MIAX and the futures are offered on the Minneapolis Grain Exchange (MGEX) via the CME Globex platform. SPIKES is calculated and disseminated every 100 milliseconds, allowing split-second views of actual market conditions, compared to the competitor, which updates every 15 seconds.
The SPIKES proprietary price dragging technique prioritizes trades over quotes and is designed to insulate the index from erratic movements in the bid-ask spread often seen in the other volatility index. The speed, reliability and accuracy of SPIKES has been received enthusiastically, and the listed futures and options offer the market participants the opportunity to diversify their volatility portfolios in a way they never before had access to — and they’re offered at substantially lower fees than the competition.
The index itself is a rolling 30-day systematic metric, while the futures and options have fixed expiration dates. The SPIKES futures and the spot level create a term structure of volatility (the spot index level makes a useful indicator but is not actually tradeable). The futures will converge toward the spot level as they approach expiration. The SPIKES options should be thought of as options on the future cash value of the index. When pricing equity index futures, such as S&P 500 futures, the spot price of the basket of stocks are the reference, but with SPIKES futures, the option prices from SPY across maturities are used to value the SPIKES futures. The futures curve then results in the current expectation of the future 30-day implied volatility.
The global factors that can increase volatility to the marketplace are growing exponentially and traders need forward-looking tools to match every investor challenge. Traders can now take advantage of a new and more affordable tool to think about and hedge against volatility.
Tom Jarck has more than 28 years of experience in equity derivatives inclusive of: volatility trading, derivatives pricing, trading and risk systems development, with specific expertise in the Index and ETF volatility marketplace in both the exchange traded and over-the-counter markets. Jarck most recently served as a volatility products consultant to MIAX and he now represents MIAX as an employee as of April 2021 as Vice President of Proprietary Product Development. Prior to his work with MIAX, he held positions at several of the largest Wall Street bank equity index volatility trading desks in director and managing director roles, including Citigroup, Deutsche Bank, and Nomura.
