Understanding and Trading Volatility Derivatives: Homework Challenge

By Lawrence G. McMillan

A few weeks ago, I had the pleasure of speaking to students in the UCLA MQE program on the topic of Understanding and Trading Volatility Derivatives. It was a data-driven, practical lecture covering the VIX, volatility ETNs, and trading strategies tied to volatility structures.

After the session, I assigned a set of homework questions to reinforce key concepts — the kind of material that goes beyond theory and gets at how volatility products behave in real-world markets.

I’m sharing those questions below. Whether you’re a student, a trader, or just interested in how these products work, I encourage you to test your knowledge.

UCLA MQE Lecture

“Understanding and Trading Volatility Derivatives”

1) You want to buy NVIDIA (NVDA), which is selling at 130, but you want to risk no more than $1,000.  Which would be your best choice?

a. Buy 100 shares of NVDA at 130 and plan to sell if it drops 10 points.
b. Buy 1 call option on NVDA that costs $1,000
c. Either one would work.

2) Microsoft (MSFT) is selling at 450.  Which of these options is in-the-money?

a. MSFT July 440 call
b. MSFT Aug 460 put
c. Both
d. Neither

3) $VIX is an estimate of option volatility how far in the future?

a. 1 day
b. 9 days
c. 30 days
d. 93 days

4) You are trying to hedge/protect a portfolio that behaves much like $SPX (the S&P 500 Index).  Which one of the following is guaranteed to be a hedge if $SPX drops in price?

a. Owning $VIX at-the-money call options
b. Owning $SPX at-the-money put options
c. Owning $VIX futures
d. All of the above

5) $VIX stays relatively close to the 20-day historical volatility of $SPX (HV20).  But which of the following is true:

a. $VIX is generally higher than HV20
b. HV20 is generally higher than $VIX
c. Neither of the above is generally true

6) With regards to the $VIX chart itself, which of the following is true?

a. Spike peaks on the $VIX chart are buy signals for the stock market.
b. When $VIX is trending higher, stocks are selling off
c. When $VIX is trending higher, stocks are rallying.
d. A & B
e. A & C

7) An example of “Term Structure” is:

a. The relationship between S&P futures prices and $VIX futures prices
b. The relationship between $VIX options prices and $VIX futures prices
c. The relationship between $VIX futures prices and their expiration dates

8) If you want to speculate on the price of $VIX going up within the next three months, you should buy:

a. $VIX futures or options that expire 3 months or more in the future
b. $VIX futures or options that expire in 2-3 weeks, and continually roll them out until $VIX rises substantially
c. $SPX puts, because if $VIX rises, the stock market will fall

9) Which of the following has a small amount of risk to the owner, due to the fact that it is actually subordinated debt of the underwriter:

a. VXX – the ETN that represents $VIX
b. $VIX itself
c. VIXY – an ETF that also represents $VIX

10) You are interested in buying $VIX August 20 call options.  What is the underlying whose price you should be following to see if your calls are in-the-money?

a. $SPX options expiring in September
b. $VIX futures expiring in August
c. $VIX itself

11) $VIX option prices display a:

a. Forward skew
b. Reverse skew
c. It depends on whether it’s a bull or bear market for stocks.

12) You are considering buying option calendar spreads as shown below.  Which one has the greatest risk?

a. CSCO: 62: buy the July 62 call and sell the June 62 call
b. SPY: 588; buy the July 590 call and sell the June 590 call
c. $VIX: 20; buy the July 20 call and sell the June 20 call