When checking out VIX Index option quotes for the first time, there is often confusion among traders regarding the proper underlying. The correct underlying pricing vehicle is the corresponding VIX Future. Note the market prices below:
VIX Index @ 16.88
VIX July 20 Put @ 2.60
It appears the VIX July 20 Put is mispriced when using the VIX index as the underlying. Taking the premium of the VIX 20 Put (2.60) and subtracting it from the option strike price (20.00) results in a value of 17.40. Comparing 17.40 to the current VIX Index level of 16.88 gives the appearance that there is negative intrinsic value in this VIX Put option. However the correct underlying is the July VIX Future which is trading at 20.30. An underlying price of 20.30 is correct and more reasonable to price this VIX option.
A second issue that arises is what to do if you do not have access to VIX futures quotes. Well here’s a little trick to determine an approximate value for the VIX futures using options.
Back to the July contract which was priced at 20.30.
Start with the deepest in the money July VIX Call Option, in this case the VIX Jul 10 Call. This market quote is below:
VIX Jul 10 Call – Bid 10.20 x Ask 10.40
Take the midpoint of the bid/ask spread: 10.30.
Add the midpoint to the call strike price: 10.30 + 10.00 = 20.30
20.30 is the market price for the July VIX Future!