Trading volatility has become increasingly popular as traders seek to profit from market fear and uncertainty rather than just price direction. The VIX offers unique opportunities, but it also comes with significant risks that you need to understand. Let us explore the practical ways to trade volatility.
Ways to Trade the VIX
You cannot buy the VIX index directly. Instead, you trade products that derive their value from VIX futures. Each has different characteristics:
Key Insight: VIX products do not track the VIX spot price directly. They track VIX futures, which behave differently. Understanding this distinction is crucial for success.
VIX Futures
VIX futures trade on the CBOE Futures Exchange and are the purest way to trade volatility. Key characteristics:
- Contract size is $1,000 times the VIX futures price
- They settle to a special opening quotation (SOQ) at expiration
- Multiple expirations available (weekly and monthly)
- Require a futures account and substantial margin
VIX Options
Options on the VIX allow you to trade volatility with defined risk. Important notes:
- VIX options settle to VIX futures, not the spot VIX
- They are European-style (exercise only at expiration)
- Great for speculating on volatility spikes
- Can be used for portfolio hedging
VIX ETFs and ETNs
For traders without futures accounts, ETF products provide access to volatility:
- VXX: Tracks short-term VIX futures (1-2 month blend)
- UVXY: 1.5x leveraged short-term VIX futures
- SVXY: Inverse short-term VIX futures (profits when VIX falls)
- VXZ: Medium-term VIX futures (4-7 month blend)
Warning About VIX ETFs
Long VIX ETFs like VXX and UVXY lose money over time due to contango. VXX has lost over 99% of its value since inception. These products are designed for short-term trading only, not buy-and-hold investing.
Strategy 1: Trading VIX Spikes
The most common VIX trade is betting on volatility spikes during market selloffs. Here is how to approach it:
Entry Signals
- VIX at historically low levels (below 12-13)
- Extended calm in the market (low realized volatility)
- Upcoming known events (elections, Fed meetings, earnings season)
- Technical breakdowns in the S&P 500
How to Execute
- Buy VIX calls (limited risk, leveraged upside)
- Buy VXX or UVXY shares (simpler, but decay risk)
- Buy VIX call spreads (reduce cost by capping upside)
Exit Plan
- Take profits when VIX spikes 50-100% from entry
- Use a time stop if nothing happens within 2-3 weeks
- Do not hold through expiration if using options
Strategy 2: Selling Volatility (Short VIX)
Because VIX tends to mean-revert and long VIX products decay, selling volatility can be profitable. But the risks are significant.
Entry Signals
- VIX spikes above 25-30 (elevated fear)
- VIX term structure in backwardation
- Panic selling appears exhausted
- Market stabilization signals
How to Execute
- Buy SVXY (inverse VIX ETF)
- Sell VIX call spreads (defined risk short volatility)
- Sell VXX put spreads
- Short VIX futures (requires substantial margin)
Risk Management
Short volatility trades can blow up catastrophically. In February 2018, the inverse VIX ETF XIV lost 90% of its value in one day and was liquidated. Always:
- Use defined-risk strategies (spreads, not naked shorts)
- Size positions small (2-5% of portfolio max)
- Have stop losses in place
- Avoid holding through major known events
Strategy 3: VIX Mean Reversion
The VIX tends to return to its long-term average of around 19-20. You can trade this tendency:
When VIX is Very Low
- VIX below 12 often precedes spikes
- Buy cheap VIX calls or call spreads
- Position size should be small (these are lottery tickets)
When VIX is Very High
- VIX above 35 often mean-reverts lower
- Sell VIX call spreads or put spreads
- Be patient; spikes can last days or weeks
Timing Tip: VIX mean reversion is reliable over weeks and months, but not days. A VIX of 40 will likely be lower in a month, but it could spike to 60 tomorrow before falling.
Strategy 4: Calendar Spreads on VIX
VIX calendar spreads exploit the term structure. Because back-month VIX futures are usually higher than front-month (contango), you can profit from this relationship:
Long Calendar Spread
- Sell front-month VIX futures
- Buy back-month VIX futures
- Profits when term structure steepens (front month falls more)
Short Calendar Spread
- Buy front-month VIX futures
- Sell back-month VIX futures
- Profits when term structure flattens or inverts (VIX spikes)
Strategy 5: Hedging Your Portfolio
VIX products can protect your stock portfolio during market crashes:
Buying VIX Calls as Insurance
- Allocate 0.5-2% of portfolio to VIX call options
- Buy calls when VIX is low (cheap insurance)
- Choose 2-3 month expirations
- Strike prices 20-50% out of the money
Rolling VIX Hedge
- Maintain a small allocation to VIX calls continuously
- Roll to new positions before expiration
- Accept that this costs money most of the time
- The payoff comes during crashes when calls spike 300-500%
Hedging Example
With VIX at 14, you buy $2,000 worth of VIX calls (0.5% of $400k portfolio). In a crash, VIX spikes to 50 and your calls are worth $12,000. This $10,000 profit offsets some of your portfolio losses.
Understanding Contango and Backwardation
This is critical for VIX trading:
Contango (Normal State)
- Future months trade higher than spot VIX
- Long VIX ETFs lose value as they roll futures
- Short VIX positions profit from the roll yield
- Occurs about 80% of the time
Backwardation (Fear State)
- Spot VIX trades higher than future months
- Indicates elevated fear and uncertainty
- Long VIX ETFs gain from the roll
- Short VIX positions lose from the roll
Common Mistakes to Avoid
- Holding VXX or UVXY long-term: These decay constantly
- Sizing too large: Volatility moves are violent; use small positions
- Ignoring the term structure: Roll costs can wipe out profits
- Shorting VIX during spikes: Spikes can get much worse before reversing
- Using market orders: VIX products have wide spreads; use limit orders
Track Your Volatility Trades
Pro Trader Dashboard tracks all your trades including VIX products and helps you analyze your volatility trading performance.
Best Practices for VIX Trading
- Start with defined-risk strategies (spreads, options)
- Keep position sizes small (1-3% of portfolio)
- Understand exactly what product you are trading
- Monitor the VIX term structure daily
- Have clear entry and exit rules before trading
- Accept that you will be wrong sometimes
Summary
Trading the VIX offers unique opportunities to profit from market volatility without picking direction. You can trade VIX futures, options, or ETF products. Popular strategies include trading VIX spikes, selling volatility, mean reversion, and portfolio hedging. The key is understanding that VIX products do not track spot VIX perfectly and managing the significant risks involved. Start small, use defined risk, and learn the nuances before committing significant capital.
Learn more about what the VIX is or read about high IV trading strategies.