VIX Futures ETNs and Their Derivatives

Abstract

This thesis studies the VIX futures exchange-traded notes (ETN) (2 and 3) and their derivatives (Chapter 4).

In Chapter 2, we examine the VIX futures ETN market's tracking performance, price consistency and price discovery. The VIX futures ETN market has become one of the main avenues for volatility trading. We show that VIX futures ETNs do not track their indicative values perfectly and are mostly inconsistently priced, at the daily and intraday level. We find that the ETNs lead the underlying VIX futures in price discovery, although this relationship is time varying, which could explain the ETNs poor tracking performance. Between the different ETNs there is no clear overall leader in price discovery; again, these dynamics are time varying.

In Chapter 3, we develop a model for the VXX, the most actively traded VIX futures ETN, using Duffie, Pan, and Singleton's (2000) affine jump diffusion, where the volatility process has jumps and a stochastic long-term mean. We calibrate the model parameters using the VIX term structure data and show that our model provides the theoretical link between the VIX, VIX futures and the VXX. Our model can be used for pricing VIX futures, the VXX and other short-term VIX futures exchange-traded products (ETPs). Our model could be extended to price options on the VXX and other short-term VIX futures ETPs.

Lastly, in Chapter 4 we document and analyze the empirical characteristics of the VXX options market, providing useful information for developing a realistic VXX option pricing model. We extend the methodology developed by \citet{zhang2008} in order to study the term structure and time series of the VXX option implied volatility curves. The implied volatility curve is quantified through three factors; the level, slope and curvature. After quantifying the implied volatility curves of the VXX options market, we show that they are not usually a smirk, as for S\&P 500 options, but rather an upward-sloping line with some convexity. As the option's maturity increases usually the level (exact at-the-money implied volatility) increases, the slope decreases and curvature increases. The level and slope factors seem to mean-revert, while the curvature factor does not follow a easily identified pattern.