OPTIONS

It's important to know everything about VIX products, from which contracts are currently available and what the strike prices are to expiration dates and settlement procedure, writes Steve Smith of Minyanville. This article was originally written on the last VIX expiration day of 2012, but its lessons are timeless.

On the last expiration day for options based on the VIX (VIX), we jump right into the deep end with this query from a reader regarding said VIX options.

Steve,

I am following the VXX (VXX) trade, but not exactly. I sold a December $18 VIX put and was just curious to know what will happen if I don't exit the trade by expiration. It doesn't seem to be like other options where you will be required to purchase the underlying stock at the strike price.

The VIX and its related products come with a whole host of idiosyncrasies in terms of pricing behavior, but that is (and has been) the topic for another column.

Let’s just keep the focus on the mechanics of VIX options and how to trade them because they do come with some quirks, such as a special opening settlement price (which I will get to below). Basically, we want to know everything, from which contracts are currently available and what the strike prices are, to the multiplier, to expiration dates and settlement procedure—right down to what the trading hours are when the market is open.

Essentially, we want to know the contract specifications. This is true not only for more complex instruments such as VIX options, but for any security or financial product. Make sure you fully understand the instrument before you invest/trade it.

Here's a quick example to illustrate the fact that quirks can come even in what may appear to be the most plain-vanilla products. The popular SPDR S&P 500 Trust (SPY) pays a quarterly dividend. What many option traders do not realize is that the ex-dividend date is nearly always the third Friday in the month of the quarter, which aligns with the regular option expiration. But this means you must be an owner of record on Thursday to qualify for the dividend. Translation: If you want the payment (which is running around 70c per share, per quarter) you would need to exercise your calls on the Thursday before expiration.

NEXT PAGE: Why VIX Options Are Different

Tickers Mentioned: Tickers: VIX, VXX, SPY