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If the spot VIX is the implied vol off of the options on the SPX Index. But which tradable product would that be? Can’t you technically only buy ETF’s that track the SPX (SPY) or buy the ES futures. The spot VIX index is calculated off the S&P500 futures or the ETF’s?

Second, if the spot is based on the Cash SPX. What would the implied vol for options on 3Month S&P futures be? Would it be the same as the 3 Month VIX futures contracts? What is the relationship between the implied vol on the SPX futures contracts and the equivalent time period VIX futures. wouldn't they be exactly the same?

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  • $\begingroup$ The VIX has a neat definition that you can find in this description from CBOE It is computed using OTM call and put options on the S&P 500 using a near and next maturity. $\endgroup$
    – statquant
    Oct 18, 2013 at 19:34
  • $\begingroup$ Yes but the S&P500 is not a tradable product. That is why ETF's and ES futures exist. Are the options based on SPY options or SPX futures? $\endgroup$
    – jessica
    Oct 19, 2013 at 15:25
  • $\begingroup$ Matt, I am really sorry. SPX is just the S&P500 index. What I am saying is how can you have options on the index when the index isn't tradable. If I buy 1 call on the SPX and it expires ITM am I going to be delivered a basket of stocks in the SPX? Or am I going to be handed a futures SPX contract. The SPX is just an index. It's not a financial product. The whole point of ETF's and Futures is to replicate this imaginary index with as little tracking error. $\endgroup$
    – jessica
    Oct 21, 2013 at 2:45
  • $\begingroup$ please see my answer, I think it makes it clearer $\endgroup$
    – Matt Wolf
    Oct 21, 2013 at 5:41

2 Answers 2

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The VIX index is based on near expiry calls and puts on the S&P 500 index. The calls and puts are referencing the index ('SPX') as underlying and are traded on the CBOE. Please note that any options or futures that reference the VIX index are cash settled. Also, for replication and hedging purposes it is important that VIX is basically nothing else than the volatility of a variance swap and because of the nature of this fact VIX can essentially be statically hedged in the underlying calls and puts.

To summarize, the tradable product are near expiry calls and puts on the S&P 500 index and you can statically replicate the VIX index by trading in the calls and puts, similarly to constructing a variance swap (though as noted above, VIX is the volatility of a variance swap not the value of the variance swap itself). The options in turn are based on the S&P 500 index

Here are some references:

Vix Product Sheet by CBOE

Vix Index Calculation

S&P500 Index Option Contract Specs

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@Matt Wolf's answer is spot on. Sometimes though, a graphical representation helps a lot in understanding things in my opinion. I recently tried to answer a question about variance swaps. I modified the code slightly to visualize what it means to compute the fair variance swap strike.

The following screenshot (and the GIF below) plot a fictional vol surface at the bottom, and computes the Fair variance swap strike as the integral of weighted prices of out-of-the-money options over all strikes. It's just the function of weighted put and call prices at different strikes and straightforward to follow graphically (the red and orange area):

enter image description here

The VIX index is essentially identical to the chart above, which has the square root of the fair variance swap strike computed via integration. One might be tempted to think that this volatility number is just the par rate of a volatility swap but a vol swap would require a convexity adjustment due to Jensen’s inequality.

The intuition behind a Var swap is that a vanilla options trader, following a delta-hedging strategy, is essentially replicating the payoff of a weighted variance swap where the daily squared returns are weighted by the option’s dollar gamma, which is highest near the strike. Taking this argument one step further, a fair variance swap can be shown to equal the integral of weighted prices of out-of-the-money options over all strikes. It follows that the par rate (or variance swap strike) is defined as:

$$ K_{var} = \frac{2}{B(0,T)T} \left[ \int_0^{F(0,T)} \frac{P(K,T)}{K^2} dK + \int_{F(0,T)}^\infty \frac{C(K,T)}{K^2} dK \right] $$ where $T$ is the contract's maturity date, $B(0,T)$ the discount factor, $P(K,T)$ and $C(K,T)$ European option prices with strike $K$ and maturity $T$ and $F(0,T)$ the forward price.

These weights are being inversely proportional to squared strikes ($1/K^2$), an application of the Black Scholes closed-form formula for gamma, which ensures results in constant dollar gamma as shown below.

enter image description here

There are two documents from JP Morgan Variance Swaps and Just what you need to know about Variance Swaps that contain the screenshot, formulas and lots of details, with the latter being more concise. Personally, I really like Towards a Theory of Volatility Trading by Peter Carr et al.

VIX Calculation

Now, you do not have a continuum of strikes available, which is why the VIX is computed using discrete values. The white paper is very clear and even replicates the entire VIX calculation step by step (only minor details like getting the correct df are ignored).

Specifically each strike that goes into the computation (there is some filtering including only options that have a non-zero bid price and the like - exact detail are described in Cboe Volatility Index® Mathematics Methodology), is computed as $$\frac{delta_K}{k^2} * df * Q(K_{i})$$.

  • $∆𝐾_𝑖 = \frac{𝐾_{𝑖+1} − 𝐾_{𝑖−1}}{2}$ is half the difference between the adjacent strike prices on either side of strike 𝐾
  • $k^2$ is strike squared
  • $df$ is the discount factor (computed with minutes to expiry accuracy from constant maturity treasury rate yield curve with cubic spline interpolation to get the yield on the expiration dates)
  • $Q(K_{i})$ is the mid of the options bid ask at that k (only OTM calls and puts are used, except for ATM, which uses the average of call and put).

The sum of all such values for all strikes (meeting the filtering criteria) for the near term (below 30 days) and next term (above 30 days) is combined to a 30 day weighted average. The filtering rules make the computation quite tedious though if you want to fully replicate it yourself.



Graphical example

However, we can make our life a lot easier by assuming we do have a continuum of strikes available. As mentioned, I'll express the variance strike as $\sqrt{K_{var}}\times 100$ to be consistent with the VIX index. Moreover, I assume dividends and interest rates are zero to skip discounting and to simplify the formula somewhat because ATMS = ATMF.


  • The details and Julia code used below can be found in this answer. For the purpose of this answer, just remember that the VIX is the area under the weighted OTM options (Puts red / Calls orange).
  • According to Black Scholes, IVOL is known and constant. This is the starting point of the GIF below (IVOL is a flat horizontal line).
  • The vol surface exists mainly because there are fat tails, skewness, heteroscedasticity, jumps (crashes), and so forth. None of these real-world phenomena are featured in the Black Scholes formula. The market just developed ways to account for many of the shortcomings of Black Scholes. You can read plenty more details here.
  • Adding skew (the line tilts to one side) or adding kurtosis (the curve bends upward), not only adjusts for the shortcoming in Black Scholes, but also adjusts the VIX (Fair Var Swap strike, shown in the chart title). Usually, VIX is higher, relative to ATM, the more pronounced skew and kurtosis are. That's why 1M ATM IVOL for SPX is usually lower compared to the VIX.

enter image description here

Making the chart interactive shows how the VIX (and Var Swap) depend on the level, it also shape of the vol surface (unfortunately imgur doesn't allow a bigger size, hence better resolution).

enter image description here

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  • $\begingroup$ Hi, thank you for your long and detailed answer! This might be a stupid question but why does one need to be constant gamma in the replication of the payoff for a variance swap? $\endgroup$
    – KaiSqDist
    Sep 28, 2023 at 20:02
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    $\begingroup$ You can have a look at the first document from JPM that I reference above, specifically point 4.4. Point 4.1 might be useful to understand the concept of dollar gamma. In a nutshell, it makes the hedge static as opposed to dynamic. $\endgroup$
    – AKdemy
    Sep 28, 2023 at 21:29
  • $\begingroup$ Thanks @AKdemy, I understood the meaning of your answer (after the reference) and also noticed that the constant gamma helps to get rid of the path-dependent volatility. Because the variance swap payoff is such that it only depends on the realized variance and the strike variance, it is necessary to use a static portfolio of options (with the necessary delta hedging) with constant gamma. $\endgroup$
    – KaiSqDist
    Oct 1, 2023 at 18:07

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