The VIX and VXX are both very popular trading vehicles for trading volatility.  But, unlike the perceptions of many traders, they are not exactly interchangeable.  There are many similarities and more importantly, some very important differences.

First, the similarities:

• Both are based on S&P 500 volatility futures
• Both will show a strong reversion to a mean level when the market is behaving itself (most of the times moving to the upside).  The VIX index and VXX will tend to quickly drop to a lower “stable” value
• Will not track the peaks of the VIX index.  The VIX futures that the VXX is based on tend to move significantly less than the VIX percentage-wise, although pretty much in time synchronization.  The is an elasticity on the tails of the price distribution.
• Because the VIX and VXX will tend to jump up dramatically in troubled times their call option implied volatility (IV) increase with higher strikes.  Normally equity call options will have their IV’s drop with higher strikes and increase on lower strikes for puts.  This IV curve is an inverse of what the equity market typically looks like.

Now, the differences:

• VXX options expire on Friday for weekly options or Saturdays—the same day as most equity/ETF options, not on the Wednesday that futures expire for that particular month.
• The VXX settlement value is the closing value of VXX on the Friday before the options expire, not the Wednesday VRO settlement value used by the VIX options
• The VXX, and hence VXX options will be sensitive to the relationship between the current and next month futures prices on volatility.  The VXX shifts its weighting between these two months on a daily basis.  Generally, this results in a price erosion force (decay) on the VXX  relative to the VIX index because the further out month is usually higher in value than the close in month (called “contango” in futures parlance)
• The implied volatility of  the VXX options should generally be lower than the equivalent VIX options because it is the mix of two months of volatility futures, not one like the VIX options.   For example, for June expiration the volatility should be about the same the day after the May VIX options expire (because both sets of options are tied to June futures) , and the VXX option volatility should decrease relative to the VIX options as the time remaining on the June options decreases and the VXX picks up more weighting in the July volatility futures.
• The VXX options have American style exercise rather than the VIX option’s European style exercise.  The European style exercise is necessary on the VIX options because the VIX options and VIX index are only guaranteed to be near each other once—at the expiration time.  The VXX and its options will naturally track each other well, so American exercise is ok.

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