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Why does the VIX sometimes gap down when the S&P 500 opens firm? In short, the CBOE Volatility Index ($VIX) is prone to gaps in the middle of the month because of the option rollover. VIX measures the implied volatility of near-term and next-term put and call options for the S&P 500. According to a rather complex formula at the Chicago Board Options Exchange (CBOE), the near-term options must have a least a week until expiry. As the middle of the month approaches, these options must be rolled to the next month to keep the formula valid. The next-term options must also be rolled over to keep them “next-term”. Otherwise, the options would have the same expiration month. Here is what happen last weekend. On the second Friday in October, VIX would be calculated with options expiring in October and November. On the following Monday, November would replace October as the near-term month because the October options would have less than a week until expiry. December would replace November as the next-term option.
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The difference in the implied volatilities will affect VIX values. Options in October, being the scary month that it is, probably carry more implied volatility than November options. Volatility is another measure of risk. This is understandable given October’s long history with the stock market. Rolling from October options with higher volatility to November options with lower volatility caused a decline in the VIX on the open. This is can be seen on Monday, October 12th. Even though the S&P 500 ($SPX) opened flat and remained flat the entire day, the VIX opened sharply lower and closed down on the day. Chalk it up to options rollover, which happens near the mid point of every month.
