As noted above we will now take this paragraph apart:
VIX futures have expiration dates, at which point the price of the future will converge with the price of the VIX index. But because of the volatility of the index, VIX futures will rarely be priced the same as the VIX index prior to expiration. This is due to the "risk premium" being priced into VIX futures. This risk premium can be thought of as insurance cost. If someone wants to protect their portfolio from a market crash by purchasing exposure to the VIX (remember, the VIX typically moves in the opposite direction as the stock market), then the entity selling them that protection will demand a risk premium for the insurance.
The first sentence has this error:
the price of the future will converge with the price of the VIX index.
If you trade the VIX futures or options and are using that as your guide, you will be inaccurate.
What actually happens is that the VIX of the month the futures are for, which for the current front month futures, March, is the VIX of April, is that that monthly VIX
becomes the VIX on the day of expiration because it's deliberately timed that way. At all times the March futures will be priced off the April VIX, and any calculations you do on those futures that use the regular VIX quoted in public will be off.
The second sentence is far worse:
But because of the volatility of the index, VIX futures will rarely be priced the same as the VIX index prior to expiration. This is due to the "risk premium" being priced into VIX futures.
This is so bad it constitutes financial malpractice.
VIX futures are very much like VIX options in this way: they have all of the characteristics of an option, such as vega, gamma, theta, and delta, except that unlike an option with a strike price they ALWAYS trade out of the money when you refer them back to
the VIX of the month they are actually for. Since options have a strike price they can wind up so far in the money that the time value disappears prior to expiration. They can also end up so far out of the money they become worthless prior to expiration.
This NEVER happens to the VIX futures, since they don't have a set strike price.
SO, just like an out of the money option, there will be a time value built into their price right up until the day of expiration. Unlike most OTM options, that time value will be non-trivial because of the Special Opening Quotation (SOQ) mechanism I explained in the first post, which introduces an extra layer of uncertainty. The SOQ means the premium will continue right up until the SOQ is published by the CBOE. Only then will it go away, and the price of the futures finally settle. The "risk premium" he refers to exists because of this uncertainty, which is indeed a product of the seller demanding a premium, but that premium always exists for the life of the future, and it does so because no one, including the CBOE, knows precisely where the SOQ will end up until it's calculated and published on the morning of expiration.
So, it isn't true that the futures will "rarely" be priced the same as the VIX: if you refer them to their proper monthly VIX, they will NEVER be priced the same. There is ALWAYS a time value in the futures. If you actually trade VIX futures as this guy says he does and don't know this, you're setting yourself up to be skinned.
The rest is just boilerplate. The point is the VIX has a lot of little details that will seriously trip you up if you don't pay careful attention, and given the variability of this index you really really don't want to be playing with anything that is related to it if you don't have all those little details nailed down.
Most people, including most pros, are better off staying away. There's far easier ways to make money in the market, and certainly far easier ways to lose it too.
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