As many of you know the VIX options are quite a unique beast. The options themselves trade as if the underlying was the VIX futures, but on the final day settle into something close to the VIX cash index. For those unfamiliar with how the options trade, at 30 days to expiration, the VIX futures will track VIX cash with a beta of about .50, thus for every 1.00 move in VIX futures (essentially the underlying for VIX options) it will move about .50. As we get toward expiration, the correlations converge. However, there can sometimes still be some odd price movement in the futures relative to cash. This can set up plays that seem somewhat favorable to option traders.
For instance, right now, I am bullish volatility. Knowing that VIX is in backwardation (a relationship where VIX futures are trading at a discount to the VIX cash) I can set up a play that naturally works in my favor. The relationship between the quickly narrowing spread of VIX cash and VIX futures will naturally pull up a call spread with one leg that is in the money. For instance, on 9/19 at 9:15 in the morning (today) The VIX futures were trading around 34.15, while VIX cash was trading about 35%. If I were to set up a bullish VIX 32.5/35 call spread despite already being completely in the money at its expiration in 2 day, the cost associated with the call spread would only be 1.50. If VIX stays here, this spread in less than 2 days will be worth 2.50.
I am not endorsing this play in particular. My point is that at expiration, if a trader has an axe to grind in one direction or another, by using the relationship between VIX and VIX futures to one’s advantage a trader can set up trades that may be statistically favorable. If this is a little confusing to you, stop trading VIX options, and go to a book store or an online bookstore and buy Russell Rhoads’ Book (Trading VIX Derivatives), he explains the above concept in great detail.