The team at FT Alphaville have been on a tear recently, analyzing all manner of VIX-related issues and potential problems. I’ve linked to those posts below, and they’re definitely worth reading even though I don’t agree with everything there.
Here are two worries about pricing and replication of VIX products that leave me unmoved. First, the matter of replicating the spot VIX index.
As Theo Casey of Futures and Options World has discussed before, it’s actually impossible to replicate the Vix, making convergence arbitrage rather an impossibility. ["What is the fair value of a VIX future?"]
Theo’s post has a quote from Jeremy Wien (a name you should recognize if you follow the VIX space): “the spot VIX itself cannot be realistically replicated, as the execution/bid-offer costs are too high, and rolling the two strips every single day would be a logistical nightmare.” That’s exactly right. While it’s a step too far to say that it is “impossible” to replicate the spot VIX index, it’s certainly impractical to do so.
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