Expected VIX Option Returns

Zhaogang Songy
Federal Reserve Board
First Draft: March 30, 2012
This Draft: October 22, 2012

ABSTRACT
We dissect the ne structure of volatility risks, as an important component of time-varying investment
opportunities, by studying returns on VIX option portfolios. In particular, we provide model-free evidence
regarding the two leading channels in modeling volatility risks: stochastic volatility-of-volatility and volatility
jumps. We nd that zero-delta straddles and delta-hedged portfolios of VIX options, which are neutral to
changes in VIX but sensitive to volatility-of-volatility, underperform zero. In contrast, tail portfolios, which
we construct by out-of-the-money and at-the-money VIX options and are only sensitive to tails risks of
volatility, outperform zero. Therefore, risks in volatility-of-volatility and jump-induced volatility tails are
priced, providing empirical support for both of the two leading channels. We further construct measures
for volatility-of-volatility and volatility tail risks, by the whole set of out-of-the-money VIX options, to
understand how they are priced relative to variance and equity risk premiums. We nd that both measures
predict short-horizon market returns, with the predictability from volatility-of-volatility risks subsumed by
the variance premium but the volatility tail risk standing as a separate channel. Dierent from existing tail
risk measures of merely market returns, our volatility tail index provides important information regarding
how investors gauge the extreme volatility risks.
KEYWORDS: Return predictability, stochastic volatility-of-volatility, variance risk premium, VIX options,
volatility tail risks

I am very grateful to Gurdip Bakshi, Itamar Drechsler, Yang-Ho Park, Andrew Patton, Yintian Wang, Hao Zhou,
and also seminar participants in the Sixth Annual Risk Management Conference at National University of Singapore
for constructive comments. I thank Min Wei for sharing her codes, and Jian Du and Nikunj Kapadia for sending me
their data. All remaining errors are solely mine. The views expressed herein are the authors and do not necessarily
reect the opinions of the Board of Governors of the Federal Reserve System.
y
Monetary and Financial Market Analysis Section, Board of Governors of the Federal Reserve System, mail stop
165, 20th Street and Constitution Avenue, Washington, DC 20551. E-mail: Zhaogang.Song@frb.gov.

Electronic copy available at: http://ssrn.com/abstract=2165584

Expected VIX Option Returns

ABSTRACT
We dissect the ne structure of volatility risks, as an important component of time-varying investment
opportunities, by studying returns on VIX option portfolios. In particular, we provide model-free evidence
regarding the two leading channels in modeling volatility risks: stochastic volatility-of-volatility and volatility
jumps. We nd that zero-delta straddles and delta-hedged portfolios of VIX options, which are neutral to
changes in VIX but sensitive to volatility-of-volatility, underperform zero. In contrast, tail portfolios, which
we construct by out-of-the-money and at-the-money VIX options and are only sensitive to tails risks of
volatility, outperform zero. Therefore, risks in volatility-of-volatility and jump-induced volatility tails are
priced, providing empirical support for both of the two leading channels. We further construct measures
for volatility-of-volatility and volatility tail risks, by the whole set of out-of-the-money VIX options, to
understand how they are priced relative to variance and equity risk premiums. We nd that both measures
predict short-horizon market returns, with the predictability from volatility-of-volatility risks subsumed by
the variance premium but the volatility tail risk standing as a separate channel. Dierent from existing tail
risk measures of merely market returns, our volatility tail index provides important information regarding
how investors gauge the extreme volatility risks.
KEYWORDS: Return predictability, stochastic volatility-of-volatility, variance risk premium, VIX options,
volatility tail risks

Electronic copy available at: http://ssrn.com/abstract=2165584

Introduction

The volatility (variance) risk has been well documented as a priced element of time-varying investment opportunities in recent years. For example, many studies have constructed variance premium
measures by model-free variance swap rates or delta-hedged gains, and found that volatility risk is
priced negatively for the S&P 500 index and either positively or negatively for individual stocks
(Bakshi and Kapadia, 2003; Carr and Wu, 2009; Driessen et al., 2009; Todorov, 2010; Vedolin,
2009). There is also a large literature of parametric option pricing models with a negatively priced
stochastic volatility factor, including Heston (1993), Bakshi et al. (1997), Bates (2000), Pan (2002);
Eraker (2004), and Broadie et al. (2007) among many others. Most recently, many eorts have
been devoted to building equilibrium models incorporating the volatility risk and exploring its asset
pricing implications, such as Bansal et al. (2012), Bollerslev et al. (2012), Campbell et al.(2012),
Drechsler (2012), and Drechsler and Yaron (2011).
Two leading channels have been employed in modeling volatility risks in both reduced-form
and structural models: stochastic volatility-of-volatility and volatility jumps. The former is used
in Bollerslev et tal. (2009), Eraker (2008), and Mencia and Sentana (2012), while the latter is
considered by Drechsler (2012), Drechsler and Yaron (2011), Eraker (2004), and Eraker et al.
(2003). However, little work has been undertaken to understand the ne structure of volatility
risks and how they are priced without relying on restrictive specications. In particular, are risks
associated with higher moments of volatility priced? If so, do investors obtain compensations for the
stochastic volatility-of-volatility as in Bollerslev et al. (2009), for the volatility tail risks associated
with volatility jumps as in Drechsler and Yaron (2011), or for both?1 How are these two risks priced
relative to variance and equity premiums? And are they spanned by risks regarding expected returns
or standing as separate channels?
Whether stochastic volatility-of-volatility and volatility tail risks are priced will validate which
mechanism is crucial to model volatility risks. And whether they stand as separate channels from
risks regarding expected returns will improve our understanding of the risk structure of equities and
corresponding premiums. In fact, the Chicago Board Options Exchange (CBOE) began to publish
values for a "VIX of VIX" Index on March 14, 2012, obviously to track volatility-of-volatility.2
Moreover, the importance of tail risks of volatility is echoed by the recently (July 29, 2011) introduced VIX Tail Hedge Index using VIX call options also by the CBOE. Measuring volatility tail
risks and corresponding premiums will rene our understanding of extreme volatility risks, dierent
from the existing studies that only focus on tail risks of returns induced by price jumps (Bollerslev
and Todorov, 2011; Du and Kapadia, 2012; Kelly, 2011).
1

David and Veronesi (2012) propose a model that endogenously generates time-varying volatility-of-volatility by
the learning process as a result of the the nonlinear updating inherent in Bayes law. In particular, when investors
are more uncertain about fundamentals, they put less weight on their current beliefs and more weight on incoming
news so that revisions to beliefs and hence volatility-of-volatility are high.
2
The VIX of VIX is calculated, using out-of-the-money VIX options, in the same way as the method to calculate
the VIX from S&P 500 options. Details can be found on www.cboe.com/micro/VVIX.

We provide model-free empirical analysis of these issues by forming appropriate portfolios of

VIX options, including calls, puts, straddles, delta-hedged positions, and tail portfolios. Conducting
empirical studies of volatility risks based on VIX option portfolios enjoys several advantages. First,
as a security associated exclusively with volatility risks, VIX options provide a pure instrument
to gauge volatility premiums. Second, compared to variance swap contracts with linear payos
in the variance, VIX options have nonlinear payos and are sensitive to high-order moments of
volatility. Hence, they are most informative about stochastic volatility-of-volatility and volatility
tail risks. Third, since VIX options were introduced by the CBOE in 2006, they have achieved huge
liquidity, becoming the third-most active contracts at the CBOE as of October 2011.3 Therefore,
VIX option prices provide direct market quotes from investors with respective to their expectations
about volatility shocks. Fourth, forming portfolios of VIX options enables us to study the economic
payo for bearing specic risks in a model-free way. For example, zero-delta straddles are immune to
small volatility movements, but sensitive to variations in volatility-of-volatility. The tail portfolios,
composed of out-of-the-money and at-the-money VIX options, can be made to single out risks
associated with left, right, or both tails. Moreover, the whole set of out-of-the-money VIX options
enables us to construct model-free measures for volatility-of-volatility and volatility tail risks.
Our study of whether there are premiums for the stochastic volatility-of-volatility as in Bollerslev
et al. (2009) makes use of straddles and delta-hedged portfolios of VIX options. We rst construct
zero-delta volatility straddles combinations of long positions in calls and puts with the same strike
and maturity that have osetting covariances with the VIX that are most sensitive to volatilityof-volatility. Using option delta values from the BlackScholes model, we nd that at-the-money
zero-delta straddles lose 6% per week on average. We further show that this evidence is robust to
perturbations of BlackScholes delta values. Corroborating results from zero-delta straddles, returns
on delta-hedged portfolios a long position in one call or put, delta-hedged with the underlying VIX
until maturity signicantly underperform zero as well. For example, delta-hedged at-the-money
calls and puts with constant maturities of 21, 28, and 35 days lose over 10% per month.
One concern about using straddles and delta-hedged portfolios is that they may reect fears of
investors for large crashes and hence contain premiums for skewness and kurtosis. To conrm that
our results are not subject to such caveats, we construct crash-neutral straddles, that is, a straddle
position with a long position in deeply out-of-the-money calls. This strategy has a net long position
in call options but earns the same return whether the market volatility increases by 20% or 50%.
We nd that returns of crash-neutral, zero-delta straddles still lose over 3% per week. Overall, our
model-free evidence shows that volatility-of-volatility risks are priced with a signicantly negative
premium.
We then study volatility tail risks by forming tail portfolios. These portfolios are sensitive to
left, right, and both tails, respectively, but all positively correlated with positive volatility shocks.
3
Average daily trading volumes of
www.cboe.com/data/pdf/QRGVol2010.pdf.

VIX

options

can

be

found

on

the

CBOE

website

at

As increases of volatility imply a deterioration of investment opportunities, the tail portfolios are
good hedges against extreme volatility risks and should earn positive returns. Moreover, they are
all made neutral to changes in the underlying with a zero delta and to changes in the volatilityof-volatility with a zero Vega, isolating the eect of tail risks induced by volatility jumps. We
nd that all three portfolios earn signicantly positive returns held to expiration, averaging over
17% and 10% per month for 25% and 15% increases (decreases) in the right (left) tail of volatility,
respectively. The portfolio sensitive to both left and right tails of volatility receives returns of 90%
and 220% correspondingly. Therefore, our results demonstrate that the volatility tail risk premium
is signicantly positive indeed, lending support to the volatility jump channel in modeling volatility
risks.
Given that risks in volatility-of-volatility and volatility tails are both priced, we next investigate
how they are associated with variance and equity premiums. A stylized consumption-based asset
pricing model with stochastic volatility-of-volatility and volatility jumps shows that these two risks
are components of both equity and variance premiums. Therefore, measures of volatility-of-volatility
and volatility tail risks are expected to predict market returns. Moreover, although the variance
premium contains components from volatility-of-volatility and volatility jumps, it does not exclude
the possibility that these two channels have stand-alone contributions to equity premiums. Finally,
adding jumps into the dynamics of market returns brings a return tail premium to both equity and
variance premiums. Given the negative correlation between returns and volatility, it is essential to
check whether volatility tail risks are spanned by risks regarding expected returns.4
Although the variance premium has been well documented to have strong return predictability
by Bollerslev et al. (2009) and Drechsler and Yaron (2011) motivated by channels of stochastic
volatility-of-volatility and volatility jumps, respectively, no studies have deciphered the ne structure
of variance premiums and their connection to equity premiums raised above. We study these issues
by constructing measures for volatility-of-volatility and volatility tail risks using the whole set of
out-of-the-money VIX options. The former is similar to the variance premium measure in Carr and
Wu (2009), and the latter is analogous to the tail measure in Du and Kapadia (2012) for S&P 500
returns.
Results based on a series of return predictive regressions give answers to the questions raised
above. First, both volatility-of-volatility and volatility tail measures predict short-horizon market
returns as expected. Second, the predictability of the volatility-of-volatility risk is subsumed by the
variance premium but the volatility tail risk stands as a separate channel. Third, the predictability
of the return tail measure is also subsumed by the variance premium, while the volatility tail
index is still signicant in predicting returns controlling the return tail index. Therefore, although
both Bandi and Reno (2011) and Todorov and Tauchen (2011) document the importance of co4
Todorov and Tauchen (2011), using high-frequency VIX data, suggest that volatility is a pure jump process and
jumps in the volatility and price level are strongly dependent with opposite signs, providing an important channel for
generating leverage eect.

jumps of volatility and price level, our results show that large volatility-specic jumps that are
not associated with extreme price changes are also priced. Hence, dierent from existing tail risk
measures of merely market returns, our volatility tail index provides important information for
investors to gauge extreme volatility shocks.
Finally, we also study expected returns of VIX calls and puts to appreciate them in the riskreturn space. Motivated by the U-shape of the pricing kernel as a function of index returns (AitSahalia and Lo, 2000; Bakshi et al., 2010a; Chabi-Yo et al., 2008), we also investigate the shape of the
volatility pricing kernel given the negative correlation between volatility and returns. Results show
that call (put) options earn returns that are signicantly negative (positive), averaging 6% (4%)
per week out-of-the-money (at all moneyness levels). This is broadly consistent with an increasing
pricing kernel of volatility. However, while both call and put returns decrease with strikes at
medium-to-large strike levels, they are increasing at low strikes, indicating a decreasing region of
the pricing kernel and hence a U-shape. The model of Bakshi et al. (2010b) with investors displaying
heterogeneous beliefs over volatility is able to accommodate such a U-shape and is supported by
our results.
To date, most studies of variance premiums only employ synthetic variance swap contracts with
linear payos on variance (Carr and Wu, 2009; Todorov, 2010). Although several works have used
VIX futures and options to study some pricing models (Sepp, 2008; Mencia and Sentana, 2011),
this paper is the rst to employ VIX options to investigate the ne structure of volatility risks by
exploring the unique nonlinear payos of options on volatility. In fact, our study makes use of a
more comprehensive dataset of VIX options than most previous studies, daily data from February
2006 when VIX options are introduced by the CBOE to April 2011.
Our approach of examining returns on option portfolios is motivated by Coval and Shumway
(2001) and Bakshi and Kapadia (2003), which validate negative volatility premiums using S&P 500
index options. Our analysis, by forming portfolios of VIX options, instead focuses on deciphering
volatility risks, motivated by state-of-the-art equilibrium models. Our study of volatility pricing
kernels is closely related to Bakshi et al. (2010b) that also uses VIX options. However, they only
examine returns on out-of-the-money options, while we document returns on calls and puts for all
the moneyness levels.
Our investigation of volatility tail risks contributes to the recent literature of tail risks. For
example, tail risk measures of returns have been proposed by Bollerslev and Todorov (2011) using
deeply out-of-the-money S&P 500 puts, by Kelly (2011) using observations of extreme returns, and
by Du and Kapadia (2012) using the dierence between the integrated variance and variance of
holding period log returns. Instead, our volatility tail index focuses on the tail risks of volatility, as
a priced element of time-varying investment opportunities. Therefore, combining our volatility tail
index and the existing return tail measures can deliver a more complete picture of extreme event
risks.5
5

A contemporaneous literature focuses on equilibrium asset pricing models with tail event risks. For example,

The rest of the paper is as follows. Section 2 rst motivates the issues we focus on by a
stylized consumption-based model with volatility risks and then constructs portfolios and indices
for volatility-of-volatility and volatility tail risks. The data is described in Section 3. Section 4
presents returns on the VIX option portfolios, while Section 5 investigates how risks in volatilityof-volatility and volatility tails are priced relative to equity and variance premiums. Robustness
checks and some further results are in Section 6. Section 7 concludes. An appendix provides some
technical details.

A Model of Volatility Risk and Volatility Option Portfolios

This section rst presents a stylized consumption-based asset pricing model with both stochastic
volatility-of-volatility and volatility jumps. We next discuss the advantage of volatility options to
analyze these two channels of volatility risks and then introduce the portfolios we focus on.

2.1

Time-Varying Volatility Risk in a Consumption-Based Framework

The basic setup is a stylized general equilibrium model with both stochastic volatility-of-volatility
and volatility jumps. It is a simplied combination of Bollerslev et al. (2009) and Drechsler and
Yaron (2011) that both build on the discrete-time long-run risk model of Bansal and Yaron (2004).
In particular, the representative agents preferences over consumption are recursive (Epstein and
Zin, 1989). Therefore, the log pricing kernel at time t+1 is
1

mt+1 = log
where

1
1

, 0 <

ct+1 + (

1)rc;t+1 ;

< 1 is the subjective discount factor,

is the intertemporal elasticity of substitution,

is the risk aversion coe cient,

ct+1 is the growth rate of log consumption, and

rc;t+1 is the time t to t+1 return on the aggregate wealth claim. We assume
throughout the paper, which implies

(1)

> 1 and

> 1

< 0. These restrictions ensure that the representative agent

has a preference for early resolution of uncertainty, which is the key for volatility risks to be priced.
The state vector of the economy is described as the following endowment processes:
ct+1 =
2
c;t+1

qt+1 =
where fzc;t g, fz

;t g,

+ Jc;t+1 ;
p
2
+
c;t + qt z ;t+1 + J
p
q + q qt + 'q qt zq;t+1 ;
c

c;t zc;t+1

;t+1 ;

and
(2)

and fzq;t g are independent i.i.d. N(0,1) processes, Jc;t+1 is a compound Poisson

Barro (2006) examines the eect of disaster risks on equity premiums using international data. Gabaix (2012) and
Wachter (2012) show that time variations in rare event risks are important to explain many stylized facts of equity
premiums. Our results, however, imply that accounting for time-varying risks of extreme volatility movements in
these asset-pricing models would improve their power in matching the data.

process with intensity

intensity

c;t

and i.i.d. jump size

;t

c
i,

and i.i.d. jump size

i

;t+1

is a compound Poisson process with

, and both jump processes are independent of each other and

c
i

of the Gaussian shocks. Moreover,

and

c ; gc )
J J

have mean and variance as (

and (

J ; gJ ),

respectively.
Observe that two shocks, zc;t+1 and Jc;t+1 , drive the randomness of the log consumption growth
rate. Furthermore, except a Gaussian shock z

to the level of volatility directly, the model

;t+1

2 ,
c;t

has two additional sources for temporal variation of the economic uncertainty proxied by
i.e., the stochastic volatility-of-volatility qt and volatility jump shock J

;t+1 .

They are the two

leading mechanisms to model volatility risks and analyze variance premiums in a consumptionbased framework. The stochastic volatility-of-volatility qt is the focus of Bollerslev et al. (2009)
in justifying the return predictability of variance premiums, while the volatility jump J

;t+1

is

documented by Drechsler and Yaron (2011) as indispensable to quantitatively match both moments
of variance premiums and standard characteristics of equity premiums.
We now solve for the equity and variance premiums, with the focus on how risks associated
with qt and J

;t+1

are priced. The standard approach for solving the model is to use Campbell and

Shillers (1988) log-linearization with rc;t+1 =

1 wt+1

wt +

ct+1 . The price-dividend ratio

wt is conjectured to be a ne in the state vector:

wt = A0 + A

2
c;t

+ Aq q t ;

(3)

where A0 > 0, A < 0, and Aq < 0 are functions of the model parameters we suppress for notational
brevity. With (2) and (3), we have
rc;t+1 =

+ ( 1A
p
+ c;t zc;t+1 + 1 qt A z
log +

1A

;t+1

A )

;t+1

2
c;t

1 Aq q

Aq q t

+ Aq 'q zq;t+1

+ Jc;t+1 :

(4)

By (1) and (4), the model-implied equity premium is

Covt (mt+1 ; rc;t+1 )

r;t

2
c;t

+ (1

2
1

A2q '2q + A2 qt + 1 +

The variance risk premium is dened as vpt;t+1

gJc

c;t

+ (1

2 2
1 A gJ

;t :

(5)

EtQ [V art+1 (rc;t+2 )]

Et [V art+1 (rc;t+2 )].

EtQ [V

art+1 (rc;t+2 )] involves

Although it is straightforward to obtain Et [V art+1 (rc;t+2 )], computing

specifying risk-neutral dynamics of the state vector. As our model is just for illustration, we avoid

this additional complication by following Bollerslev et al. (2009) to use a log-linear approximation:6
EtQ [V art+1 (rc;t+2 )]

h
log e

rf;t

1
V art [V art+1 (rc;t+2 )]
2
A + Aq 21 A2 + A2q '2q '2q qt

Et emt+1 +V art+1 (rc;t+2 )

Et [V art+1 (rc;t+2 )] + (
+(

1)

1A

+(

1)

c
c;t J

+ (

;t J

1)

1h
2

1)
2

1A

1)2

+(

1
(
2

1)2

2 2
1A

;t gJ

c
c;t gJ ;

which implies that

vpt;t+1 = (

1)

2
1

A + Aq

+ (

1)

1A

+ (

1)

c
J

A2 + A2q '2q '2q qt

+ (

1h
2

1)
2

+(

1A

1
(
2

i
1)2 gJc

1)2
c;t :

2 2
1A

gJ

;t

(6)

A comparison of (5) and (6) delivers the following testable implications. First, risks of stochastic
volatility-of-volatility and volatility jumps are priced as components of both the equity and volatility
premium. Second, jump risks of log consumption growth rate are also priced in both premiums.
Third, as a combination of premiums for qt , J

;t ,

and Jc;t that enter the equity premium, the variance

premium is expected to predict market returns. Fourth, the return predictability of stochastic
volatility-of-volatility, volatility jump, and consumption jump premiums may or may not be fully
subsumed by the variance premium.
The return predictability of variance premiums have been well documented in Bollerslev et al.
(2009, 2011), Drechsler and Yaron (2011), and Zhou (2010). Moreover, Bollerslev and Todorov
(2011) and Du and Kapadia (2012) propose model-free measures of Jc;t and nd that tail risks
induced by price jumps are important components of

r;t

and vpt;t+1 , while the predictability of

price tail premiums for market returns is only through variance premiums. In contrast, no studies
have proposed model-free measures for qt and J

;t+1

and analyzed their connections with equity

and variance premiums, making the picture of variance risks incomplete and vague. We argue that
current studies only based on synthetic variance swaps cannot answer these questions, as the swap
rates mainly reveal the conditional mean of return variation (Carr and Wu, 2009). Instead, we ll in
this gap by utilizing options written on volatility that are sensitive to higher moments of volatility
by design.
6

See Drechsler and Yaron (2011) for a full solution by assuming a ne specications for risk-neutral dynamics.

2.2

Volatility Option Portfolios

We rst discuss the advantage of volatility options to analyze the role of stochastic volatility-ofvolatility and volatility jumps and then introduce the portfolios we rely on. From now on, let
vt;T 2 (0; 1) represent the market return variability from time t to T that can be measured in

2 by an estimate
dierent ways. For example, most existing studies of variance premiums measure vt;T

of the quadratic variation of log returns (Bollerslev et al., 2009; Carr and Wu, 2009; Todorov, 2010).7
2
We denote h vt;T

the payo function of a volatility-contingent claim. For the model from the last

2
section, there exists a pricing kernel mt;T that can price h vt;T
.8 As we mainly focus on volatility

securities, it su ces to work with the projection of the pricing kernel onto the space generated by
2
vt;T , denoted as m (vt;T ).9 Therefore, the price Zt;T of the volatility-contingent claim h vt;T

Zt;T =

1
2
Et m (vt;T ) h vt;T
Rf

is
(7)

where Rf is the risk-free rate between time t and T .

Existing studies of variance premiums consider the variance swap contract with a payo to the
2
long position equal to vt;T

st;T , where st;T is the variance swap rate and vt;T is proxied by the

quadratic variation.
As a variancei swap contract has zero net market value at entry, (1) implies
h
P
2
that 0 = Et m (vt;T ) vt;T
st;T
and hence
2
st;T = Et m (vt;T ) vt;T
:

(8)

2
Therefore, st;T can be regarded as the price of a volatility-contingent claim with payo h vt;T
2 .
vt;T

An inspection of (8) shows that variance swaps are generally not informative about higher

2
moments of volatility due to the linear payo function h vt;T

2 .
= vt;T

We turn to volatility options with nonlinear payo functions. Consider a call option with its
payo (vt;T
in

(8).10

K)+

max (vt;T

K; 0) written directly on the same proxy of volatility as that used

An application of (7) shows that the price Ct;T of a volatility call is

Ct;T =

1
Et m (vt;T ) (vt;T
Rf

K)+ :

(9)

A comparison of (8) with (9) shows that the nonlinear payo function makes the option very
7

Alternatively, Sassan et al. (2002) and Brandt and Diebold (2006) proposed range-based volatility measures
The existence of such a pricing kernel can also be justifed by no-arbitrage arguments (Du e, 1992; Harrison and
Kreps, 1979).
1
9
2
2
The price of a volatility security with payo h vt;T
is Rf
Et mt;T h vt;T
. By the law of iterated ex8

2
2
2
2
pectation, the price is equal to Rf
Et Et mt;T h vt;T
jvt;T
= Rf
Et Et mt;T jvt;T
h vt;T
, where
2
m (vt;T ) = Et mt;T jvt;T . Accordingly, all that is required for volatility securities is m (vt;T ).
10
Rigorously, the underlying of volatility options diers from that of variance swap rates by a convexity term.
However, both refer to the same stochastic drivers, and ignoring the convexity term will not change our results of
whether and how risks of stochastic volatility-of-volatility and volatility jumps are priced.

sensitive to higher moments of volatility, providing sensible information about stochastic volatilityof-volatility and volatility jumps. In the next section, we rst document general properties of the
volatility pricing kernel m (vt;T ) and then returns on volatility calls and puts.
2.2.1

Calls and Puts

We study returns on calls and puts to shed light on the risk-return relationship for products of the
volatility market. In particular, we ask whether m (vt;T ) is always monotonically increasing with
volatility or exhibits a U-shape. The former implies a negative variance premium while the latter
predicts a positive sign at low volatility levels. We characterize patterns of expected call and put
returns under both the monotonically increasing and U-shaped pricing kernels of volatility. Let Pt;T
denote the price of a volatility put. Then the the returns on volatility calls and puts can be dened
C
as rt;T

(vt;T

K)+ =Ct;T

P
1 and rt;T

(K

vt;T )+ =Pt;T

1, respectively. For call returns, we

have
Proposition 1: (i) If m (vt;T ) is increasing in vt;T over (0; 1), then the return on a volatility

C , is negative and decreasing in the strike. (ii) If m (v

call, rt;T
t;T ) exhibits a U shape, decreasing on

C is negative and decreasing at relatively high strikes but

(0; K ] and increasing on [K ; 1), then rt;T

could be positive and increasing at su ciently low strikes.

For put returns, we have

Proposition 2: (i) If m (vt;T ) is increasing in vt;T over (0; 1), then the return on a volatility

P , is positive and decreasing in the strike. (ii) If m (v

put, rt;T
t;T ) exhibits a U shape, decreasing on

P is positive and decreasing at relatively high strikes but

(0; K ] and increasing on [K ; 1), then rt;T

could be negative and increasing at su ciently low strikes.

Propositions 1-2 extend the theoretical results on expected returns of market index options in
Coval and Shumway (2001) to the case with volatility options and U-shaped pricing kernels. They
are similar to Theorem 1 of Bakshi et al. (2010b) except that they consider a pricing kernel projected
on both the market return and volatility, while we only study the pricing kernel projected on the
volatility space. This dierence results from the dierent focuses: Bakshi et al. (2010b) try to set
up an equilibrium model of volatility trading that is suited to the market data, while we aim to
decipher the ne structure of variance risks empirically.
Propositions 1-2 imply that volatility call (put) returns are negative (positive) and decreasing
with strikes in general. However, positive returns on deeply in-the-money calls or increasing patterns
with moneyness will support a U-shaped m (vt;T ). Analogously, negative returns of deeply out-ofthe-money puts or increasing patterns with moneyness also support a U shape for m (vt;T ).
2.2.2

Straddles and Delta-Hedged Portfolios

Returns on volatility calls and puts do not allow us to make conclusions about volatility-of-volatility
and volatility jumps, which are mixed with each other and polluted by jumps in the consumption

growth rate, as shown in (5) and (6). We purge the compensation for variability of the underlying by
forming portfolios that are most sensitive to changes in volatility-of-volatility. Motivated by Coval
and Shumway (2001) and Bakshi and Kapadia (2003), we propose to employ zero-delta straddles
and delta-hedged portfolios of volatility options.
C
t;T

The delta of a call (put) option of volatility,

P ),
t;T

measures the sensitivity of the option

price with respect to the underlying volatility vt;T . We follow Coval and Shumway (2001) and
Bakshi and Kapadia (2003) to compute them as the BlackScholes hedge ratio, hence
C
t;T

= N

1
p
t;T T

P
t;T

= 1

C
t;T ;

log(vt;T =K) +

1
2

t;T

t
(10)

where N [ ] is the cumulative normal distribution,

t;T

is the volatility-of-volatility over [t; T ] and the

second equation follows from putcall parity. Both zero-delta straddles and delta-hedged portfolios
are made neutral to movements of vt;T with a zero delta by combining positions of calls and puts
for the former and positions of calls or puts that are delta-hedged until expiration for the latter.
In particular, the zero-delta straddle comprises buying one call and
C
t;T

same maturity and strike so that the delta of the portfolio equals

C = P puts with the

t;T
t;T
P (
C = P ) = 0.
t;T
t;T
t;T

The return of this portfolio is hence

rt;T =

K)+

(vt;T

(vt;T

Ct;T
K)+
Ct;T

C (v
t;T
t;T
C P
t;T t;T =

K)+ =

P
t;T

P
t;T

C (v
K)+ =(1
t;T
t;T
C P
C )
t;T t;T =(1
t;T

C )
t;T

1;

(11)

where (10) is used in the second equality. Therefore, we only need the delta value of the call option
in computing rt;T .
For delta-hedged portfolios, we consider a call that is hedged discretely N times over [t; T ], where
the hedge position is rebalanced at tn , n = 0; 1;

;N

1 with t0 = t and tN = T . Therefore, this

portfolio is delta neutral and not sensitive to variations of the underlying volatility at all of these
dates until the maturity. The return is hence rt;T;C =
C
t;T

= (vt;T

K)+

Ct;T

N
X1

C
tn ;T

vtn+1 ;T

vtn ;T

n=0

where

tn

is the risk-free rate and

delta-hedged gain

P
t;T

and returns

C =
t;T

C v
t;T t;T
N
X1
n=0

C
tn ;T
rt;T;P

tn

Ct;T , where

Ct;T

C
tn ;T vtn ;T

t
N

; (12)

is the hedge ratio on date tn . Similar expressions for the

can be obtained analogously with put option prices and

delta values.

10

2.2.3

Tail Portfolios

Besides the risk in the volatility-of-volatility, returns on volatility options are also sensitive to
even higher (of order larger than 3) moments of volatility, skewness and kurtosis for instance.
These higher moments are closely associated with volatility-jump-induced tail risks because volatility
options provide hedges against large-scale volatility increases and hence market declines because of
the negative correlation between market returns and volatility (French et al., 1987, and Glosten
et al., 1993). We construct portfolios that are mainly subject to these tail risks and investigate
whether they are priced. As usual, we remove the exposure of these tail portfolios to changes in
the underlying volatility with a zero delta and to changes in the volatility-of-volatility with a zero
Vega.
As payo functions of out-of-the-money volatility calls and puts are only determined by the left
and right volatility tails, respectively, we construct three types of portfolios that are sensitive to
only the left tails (L-Tail portfolio), only the right tails (R-Tail portfolio), and both tails (LR-Tail
portfolio). Moreover, we make all three portfolios positively (negatively) correlated to the right
(left) volatility tails and hence their payos increase as the probability of a high (low) realized
volatility is increased (decreased). Hence, we expect returns on them to be positive if volatility tail
risks are indeed priced.
M
M
The L-Tail portfolio consists of shorting one out-of-the-money volatility put, buying #OT
=#AT
P
P
P;OT M
t;T

at-the-money puts, and a volatility position of (

M
#OT
P

P;AT M
M
=#AT
),
P
t;T

M
where #OT
and
P

M
#AT
are Vegas of out-of-the-money and at-the-money volatility puts, respectively.11 The delta of
P

this portfolio is equal to

P;OT M
t;T

M
+ #OT
P

P;AT M
M
=#AT
P
t;T

P;OT M
t;T

M
#OT
P

P;AT M
M
=#AT
P
t;T

= 0:

(13)

Moreover its Vega is

M
M
M
M
#OT
+ (#OT
=#AT
)#AT
= 0:
P
P
P
P

(14)

Hence, L-Tail portfolio is indeed both delta and Vega neutral. To verify its payo is negatively
correlated with the left tail, we rst note that both puts in this portfolio have changes in payos
only when the left tail of the volatility changes. Lowering the left tail, we have a smaller probability
of low volatility levels, which implies smaller payos for the two puts simultaneously. Because
the out-of-the-money put has a larger decrease in payos than the at-the-money put, the shorting
position in the L-Tail portfolio ensures a higher value for the portfolio at expiration, which conrms
that the portfolio payo is decreasing in the left tail. Therefore, this Left-Tail portfolio singles out
the lefttail risk of the volatility.
11
Such a strategy is actually a put spread combined with positions in the underlying to make the portfolio both
delta and Vega neutral. Bali and Murray (2011) employ similar strategies and explain the risk they are exposed to as
the skewness. We treat them as assets sensitive to the tail risk, as they are sensitive to risks associated with not only
skewness but also kurtosis and even higher moments (of order higher than 2).

11

M
M
The R-Tail portfolio consists of buying one out-of-the-money volatility call, shorting #OT
=#AT
C
C
C;OT M
t;T

at-the-money calls, and a volatility position of (

M
+ #OT
C

C;AT M
M
=#AT
).
C
t;T

Similar to (13)-

(14), we can verify that the R-Tail portfolio is also delta and vega neutral. Moreover, its payo is
increasing in the right tail of volatility, hence isolating the risks associated with the right tail. Finally,
M
M
the LR-Tail portfolio consists of buying one out-of-the-money volatility call, shorting #OT
=#OT
C
P

out-of-the-money puts, and a volatility position of (

C;OT M
t;T

M
+ #OT
C

P;OT M
M
=#OT
).
P
t;T

It can also

be veried that the LR-Tail portfolio is delta and vega neutral, and its payo is both negatively
correlated with the left tail and positively correlated with the right tail. Therefore, the LR-Tail
portfolio incorporate risks of both tails of volatility.
The returns on these three portfolios can be calculated by the net payos of the positions held
until maturity divided by the entering costs. They provide us a complete picture of whether and
how investors perceive the tail risks and hence volatility jumps. Furthermore, by changing the
moneyness levels of the out-of-the-money calls and puts in the portfolios, we can examine premiums
of tail risks at dierent scales, for example, a 15% versus 25% volatility increase.

2.3

Measuring Volatility-of-Volatility and Volatility Tail Risks

Portfolios of the volatility options above are most eective to answer whether risks of stochastic
volatility-of-volatility and volatility jumps are priced. However, to gauge the premiums for these
two risks and examine their relationship with equity and variance premiums shown in (5) and (6),
we need direct quantitative measures.
As stochastic volatility-of-volatility is about the temporal variation of return volatility, we dene
a volatility index of volatility (V IXV ) by constructing variance swap contracts written on volatility
using volatility options. In particular, let RV denote the realized annualized variance of the volatility
vt;t+ from time t to T . A variance swap contract on vt;t+ pays the dierence between RV and a
swap rate determined at the initiation of the contract. Similar to Carr and Wu (2009), the swap
rate is equal to EtQ [RV], i.e., the risk-neutral expectation of the realized variance. Assuming vt;t+
follows a diusion process, then EtQ [RV] = IV, which is the annualized integrated variance and can
be computed by out-of-the-money volatility options with maturity T ,
IV

2er(T
T

t)

(Z

vT;T +

1 T
P (K)dk +
K2 t

vT;T +

1 T
C (K)dk
K2 t

r(T t)

er(T

t)

where r is the risk-free rate from time t to T . Our V IXV is dened as V IXV = IV

r(T

)
i
t) ;
(15)

RV, which

essentially equals the variance risk premium of volatility associated with qt in (2).
An important point emphasized by Du and Kapadia (2012) is that IV diers from EtQ [RV]
by terms due to the volatility jump J

;t+1 .

Although this dierence is a drawback for measuring

variance risk premiums, it is a benet for us to separate volatility-of-volatility and volatility jumps
and dene appropriate measures for both. Specically, the swap rate IV dened in (15) only includes
12

the volatility-of-volatility qt in computing V IXV and leaves out J

;t+1 .

Therefore, V IXV indeed

mainly captures premiums for the volatility-of-volatility risk.

To quantify the volatility tail risk due to J

;t+1 ,

we follow Du and Kapadia (2012) to consider

the following measure for variance premiums of volatility that incorporates volatility jumps:

8
1 < r(T
2e
T :

2
Z
t) 4

vT;T +

K
ln vT;T
+

K2

PtT (K)dK +

where

t;T

= er(T

t)

vT;T +

K2

CtT (K)dK 5

2
t;T

9
=
;

(16)

T
IV:
2

As V is the swap rate of the variance swap contract incorporating J

and tail index as V T IX

K
ln vT;T
+

;t+1 ,

we dene a volatility jump

IV, which is determined by higher moments (of order

3) of the

volatility jump distribution as can be shown following the arguments of Du and Kapadia (2012).12
With the two indices V IXV and V T IX, we can study whether they predict market returns as
expected by (5). Going one step further, we can investigate whether the predictability of V IXV
and V T IX are only through the variance premium vpt;T or present additional channels in light
of (6). The former implies we can content with a variance premium measure in studying market
returns while the latter shows the importance of accounting for information in volatility options to
understand equity premiums. Finally, the V T IX measure allows us to investigate whether volatility
tail risk is priced in both equity and variance premiums only through the correlation with return
tail risks. If that is not the case, then our V T IX measure would serve as an additional index for
investors to gauge extreme event risks.

The Data

Going to the data, the volatility is measured by the VIX index vt;t+30 , as in Bakshi et al. (2010b).
We employ daily observations on VIX options over a ve-year period from March 2006 to April
2011, obtained from OptionMetrics. The dataset contains daily closing bid and ask prices of both
call and put options on the VIX, along with implied volatility, delta and vega. We also obtain daily
VIX series and zero coupon yield data from OptionMetrics.
12
Also noticing the drawback of IV in capturing jumps, Martin (2012) introduces a simple variance swap that can
be priced and hedged even if the underlying assets price can jump. He also constructs a robust measure of the
risk-neutral market volatility. In the same logic, we can dene a similar measure for volatility-of-volatility
(Z
)
Z 1
vT ;T +
2er(T t)
1 T
1 T
2
SVIX
Pt (K)dk +
C (K)dk
2 t
T
K2
vT ;T + K
0

that is robust to jumps. Furthermore, we can construct a volatility jump and tail index as IV SVIX2 similar to
V IV. Empirical results using IV SVIX2 are very similar to those in Sections 5 and 6 by V IV and are available
upon request.

13

We clean the data using several lters. First, we exclude options with zero open interests or
trading volumes. Second, we discard options with bid quotes equal to zero or negative bidask
spreads. To mitigate the eect of price recording errors, observations with bid or ask prices less
than 0.05 are also eliminated. Finally, we only consider options with maturity larger than a week
and less than 60 days for liquidity concerns. Our focus on these short-term options also makes our
results robust to the impact of stochastic interest rates. For each option, we take the mid-quote as
the option price. Our sample ultimately contains a total of 47,256 VIX option prices, with 29,167
calls and the 18,089 puts.
Table 1 provides summary statistics for our sample of VIX options across moneyness, measured
by strike divided by the underlying price.13 As expected, the call (put) price is negatively (positively) associated with moneyness. Most interestingly, the liquidity pattern of VIX options across
moneyness is substantially dierent from that of S&P 500 options. As is well known, the liquidity of
in-the-money S&P 500 options is seriously worse than near-the-money options. In contrast, Table
1 shows that VIX calls and puts that are 5% to 15% in the money have similar liquidity to their
near-the-money counterparts in terms of both the number of contracts and the average trading
volumes. For example, VIX calls with moneyness in (0.8,0.95] has contracts of 13.81% of the total
call contracts, larger than 9.70% for calls with moneyness in (0.95,1.05].14 The nal observation is
that deep out-of-the-money calls and in-the-money puts are the most liquid VIX options, as they
are closely related to volatility increases and market declines.
As discussed in Section 2, both delta-hedged and tail portfolios require investments in the VIX
that is not tradable directly. As a solution, we use VIX futures as the tool to trade volatility. The
daily VIX futures prices can be obtained directly from the CBOE website, along with the trading
volume and open interest. We apply several exclusion lters to the raw data. For example, we
exclude VIX futures with zero open interests or trading volumes due to liquidity concerns. We also
delete futures contracts with prices less than 0.5 to mitigate the impact of prices discreteness.15
Panel A of Figure 1 plots daily time series of VIX index over our sample period of March 2006 to
April 2011, along with the one-month VIX futures price. It is observed that the futures prices are
close to the spot VIX in general, with discrepancies at regions with peaks. To put the VIX index
of our sample period in historic perspective, Panel B of Figure 1 plots the VIX time series starting
from 1990.
13

These summary statistics are for our cleaned sample data that only contain VIX options with maturities between
one week and two months. Unreported summary statistics show that the patterns we document here are representative
of VIX options with maturities between one month and half a year that are mostly liquid.
14
For a fair comparison, we nd that the percentages of VIX calls with moneyness in (0.8, 0.9] that has the same
length as (0.95, 1.05] is equal to 10.53%, which is fairly close to, though not larger than, the percentages of options
with moneyness in (0.95,1.05].
15
The underlying value of VIX futures contract is VIX times 10 prior to March 26, 2007. We follow the rescaling
method of the CBOE Futures Exchange to divide the contract prices by 10 and bring the traded futures prices in line
with the underlying VIX index.

14

Returns of VIX Option Portfolios

This section documents empirical characteristics of returns on calls and puts, straddles and deltahedged portfolios, and tail portfolios. The questions we address are the shape of the volatility
pricing kernel and premiums for risks in volatility-of-volatility and volatility tails.

4.1

Call and Put Returns

Table 2 reports statistics of weekly VIX option returns over the ve-year sample period of March
2006 to April 2011, with results for calls in Panel A and those for puts in Panel B. We follow Coval
and Shumway (2001) to consider weekly returns because of the short sample period of available VIX
options. But dierent from the overlapping returns they employ, our weekly returns are computed
by holding a 30-day option for one week at the weekly frequency, which delivers a non-overlapping
weekly return series. We divide both calls and puts into six groups according to the moneyness,
dened as strike over the underlying VIX value. Note that we consider a large scale of moneyness
level because deeply away-from-the-money VIX options are at least as liquid as near-the-money
contracts, as documented in Table 1.
We record a variety of statistics, including mean, median, minimum, and maximum, for each
of the six moneyness groups. Because of the well-known skewness of option returns and small
sample concern, we report both normal distribution-based t-statistics and p-values, along with
bootstrapped p-values calculated by B=25,000 bootstrap draws.16 Panel A shows that the mean
returns of VIX calls are signicantly negative across moneyness levels, except deeply in-the-money
at 0.750.85. For example, an at-the-money call loses 11.54% per week, both economically and
statistically signicant. In contrast, VIX puts earn positive average returns across all groups of
moneyness. An at-the-money put tends to earn an average return of 6.51%. In general, the signs
of average call and put returns provide no evidence against an increasing volatility pricing kernel.
Moreover, the median, minium and maximum demonstrate that both VIX call and put returns
exhibit a substantial positive skewness, except the deeply in-the-money put returns. As a result,
bootstrapped p-values are mostly larger than the conventional p-values based on normality.
We then study the shape of the volatility pricing kernel from the perspective of option returns
across moneyness levels. Panel A shows that VIX call returns are decreasing with moneyness while
Panel B implies put returns are decreasing with moneyness in general but with reversals at levels of
0.750.85 and 1.051.15. However, we cannot draw conclusions directly about the pattern of option
returns with respect to moneyness without considering statistical uncertainties. To make rigorous
inferences, we use the MR test proposed in Patton and Timmermann (2010) that explores the full
set of implications of monotonic patterns.17
16
As the autocorrelation of the weekly returns is fairly small, we perform i.i.d. bootstrap. We also tried the
parametric bootstrap based on the BlackScholes model favored by Broadie et al. (2009) and block bootstrap, both
of which can account for time-series correlations. The results are similar to those using the i.i.d. bootstrap.
17
We also test the inequality relationship of the adjacent pair of moneyness groups. Results show that we cannot

15

In particular, we test the null hypothesis of decreasing in-the-money (out-of-the-money) VIX

call (put) returns with moneyness in the rst three groups. The bootstrapped p-values in Panels
A and B (based on B bootstrap samples) show that the decreasing pattern is rejected for in-themoney calls at the 7% signicance level but not for out-of-the-money VIX puts. This evidence is
in sharp contrast to the naive observation that deeply in-the-money (out-of-the-money) VIX call
(put) returns exhibit some decreasing (increasing) regions. We also report the MR test for outof-the-money (in-the-money) call (put) returns with moneyness in the last three groups and nd
no rejection against the decreasing pattern. Therefore, it is the in-the-money call returns that
cast evidence against a uniformly increasing volatility pricing kernel and support the heterogenous
beliefs model of Bakshi et al. (2010b) that can support a U-shape volatility pricing kernel.18

4.2

Returns on Straddles and Delta-Hedged Portfolios

We direct our attention on the returns of zero-delta straddle to determine whether risks associated with stochastic volatility-of-volatility are priced, consistent with Bollerslev et al. (2009). As
discussed in Section 2, zero-delta straddle returns are sensitive to volatility-of-volatility but not to
the underlying VIX. Hence, their expected returns are negative if there is a premium for stochastic
volatility-of-volatility.
Table 3 reports statistics of weekly zero-delta straddle returns across ve moneyness groups. As
before, the weekly returns are computed by holding a 30-day zero-delta straddle position for one
week at the weekly frequency. We record the mean, median, minimum and maximum returns, along
with the conventional t-statistic and p-value for the null hypothesis of zero expected returns and
also bootstrapped p-values by B bootstrap draws. The results with Black-Scholes deltas show that
average returns on zero-delta straddles are signicantly negative at the 5% level across dierent
moneyness groups, except that the signicance level for the group with moneyness in (1.15, 1.25] is
10%. At-the-money straddles lose 6.59% per week and deeply in-the-money straddles lose the most.
To check the robustness of our results to beta calculations, we allow for measurement errors that are
10% above and below the Black-Scholes deltas. As we can see, all the returns remain signicantly
negative, suggesting that risks in volatility-of-volatility are indeed priced.
We then consider the second set of portfolios subject to risks in volatility-of-volatility, i.e., the
delta-hedged calls and puts. Results of returns on VIX calls hedged discretely until expiration are
reported in Table 4 while those for VIX puts are reported in Table 5. For each of the ve moneyness
groups, we pick options with maturities that are closest to 30, 44, and 58 days and delta hedge them
reject the null hypothesis that low-moneyness options earn higher returns in each pair for both calls and puts although
some negative dierences are observed for puts in a pair.
18
Our results are very dierent from those of Bakshi et al. (2010b) who nd that out-of-the-money put returns
support the U shape and both call and put returns are not statistically dierent from zero. The dierent results
could be due to the dierent sample periods (March 2006 to April 2011 versus to September 2010), dierent sampling
frequencies (weekly versus monthly), dierent price quotes (mid-quote versus ask quote), and dierent moneyness
schemes (moneyness groups versus options with the moneyness closest to a predetermined level).

16

until expiration.19 This practice delivers three non-overlapping return series at 30-day, 40-day, and
58-day frequencies, respectively.
Looking at returns of delta-hedged calls in Table 4, we nd that they are signicantly negative
across maturities and moneyness, with the only exception of 44-day call with moneyness in (1.15,
1.25]. For example, returns on at-the-money delta-hedged calls lose 11.70%, 10.31%, and 18.65% for
maturities of 30, 44, and 58 days, respectively. For returns of delta-hedged puts in Table 5, we see
that returns of delta-hedged deeply in-the-money puts are not signicantly negative. But both deltahedged out-of-the-money and at-the-money puts earn signicantly negative returns. The latter, for
example, lose 11.01%, 18.03%, and 32.94% for maturities of 30, 44, and 58 days, respectively.20
Moreover, we note that delta-hedged deeply in-the-money puts earn puzzling signicantly positive
returns of 12.23%. Similar to Bakshi and Kapadia (2003), we conjecture that the relative illiquidity
for in-the-money puts may upwardly bias the mean returns. This conjecture is veried by observing
that returns on delta-hedged deeply out-of-the-money calls that are equivalent to deeply in-themoney puts but much more liquid 10,363 contracts versus 4,831 contracts as shown in Table
1 lose 11.37% at the 1% signicance level.
Although straddles and delta-hedged positions are most sensitive to changes in volatility-ofvolatility, they also hedge risks associated with large market crashes that are accompanied by
extreme increases of volatility. To deal with this concern in concluding nonzero risk premiums
for volatility-of-volatility by returns on straddles and delta-hedged positions, we consider a crashneutral zero-delta straddle. Such a portfolio consists of a long straddle position and a short position
of deeply out-of-the-money calls, i.e., buying one at-the-money call, shorting one out-of-the-money
call, and buying (

OT M
C

AT M )=
C

AT M
p

at-the-money put. Suppose the out-of-the-money call

is p percent larger than the strike. It can be veried that this crash-neutral zero-delta straddle
has a zero delta, and its payo increases as the volatility increases by p percent while remaining
unchanged when the volatility increases further. By changing p, we can control the sensitivity of
the portfolio payo to dierent scales of large market crashes.
Table 6 reports statistics of weekly returns on the 30-day crash-neutral zero-delta straddles with
ve moneyness levels for the out-of-the-money call. To achieve the target moneyness level p, we
select the call option with the highest available strike that is at most p percent higher above the
underlying VIX value. We observe that the reported average moneyness levels of employed outof-the-money calls match the target levels well. Most importantly, the returns on crash-neutral
zero-delta straddles are all signicantly negative across p. They range from -2.94% to -3.96% that
are lower than the -6.59% of at-the-money straddles and decrease with the moneyness of the out19

The results reported here for delta-hedged calls and puts employ the BlackScholes deltas. Similar to the case
of call and put returns, we also experimented with measurement errors in the delta calculations and found similar
results.
20
Note that returns on delta-hedged calls and puts are much higher than those on zero-delta straddles, although
both are sensitive to risks associated with volatility of volatility. The reason is that delta-hedged positions with 30-day,
40-day, and 50-day options held until maturity deliver returns over longer periods than weekly straddle returns.

17

of-the-money call. This pattern implies that (1) the returns of straddles do contain premiums for
market crash risks, and (2) abstracting from crash risks, signicantly negative returns on crashneutral zero-delta straddles conrm that risks associated with volatility-of-volatility are indeed
priced. Therefore, our results show that the mechanism through stochastic volatility-of-volatility in
Bollerslev et al. (2009) is empirically valid to endogenize volatility risks of the consumption growth.

4.3

Returns on Tail Portfolios

The anecdotal evidence in the last section that crash-neutral straddles have returns lower than zerodelta straddles indicates the existence of premiums for volatility tail risks associated with volatility
jumps. We now formally study the tail risk premiums by computing returns of tail portfolios.
We report returns on 30-day L-Tail, R-Tail, and LR-Tail portfolios held until maturity in Panels
A, B, and C of Table 7, respectively. We record the mean returns, positions of options and the
underlying VIX, and average moneyness levels of calls and puts, along with conventional t-statistic
and p-value for the null hypothesis of zero expected returns and also bootstrapped p-values by B
bootstrap draws. For both left and right tails, we consider two levels of tail events, yL = 0:75; 0:85
and yR = 1:15; 1:25. The former corresponds to a 25% and 15% downward jump of volatility levels
while the latter represents a 15% and 25% upward jump. To achieve the target moneyness levels
yL and yR , we select the out-of-the-money calls and puts with the highest available strike that is
not larger than the target levels. The reported average moneyness levels in Table 7 show that they
closely match the objective yL and yR .
We observe that returns on all of the tail portfolios are signicantly positive, mostly at the 5%
signicance levels using bootstrapped p-values. For example, with yL = 0:85 and yR = 1:15, the
L-Tail, R-Tail, and LR-Tail earn 9.90%, 31.19%, and 90.53% per month, respectively. Returns on RTail and LR-Tail portfolios are substantially higher than those of L-Tail portfolios, suggesting that
investors are more sensitive to the right tails of volatility and hence upward volatility jumps that
usually accompany large market declines. Furthermore, for each set of tail portfolios, returns are
increasing substantially with the magnitude of large volatility changes. This pattern implies that the
market prices severe volatility tail risks exceedingly high. Overall, our results empirically conrm
the importance of Drechsler and Yarons (2011) mechanism of volatility jumps in endogenizing
volatility risks of the consumption growth. Of course, it is not clear so far whether the volatility tail
premium is mainly dictated by its correlation with price tails that have been studied in Barro (2006),
Bollerslev and Todorov (2011), Du and Kapadia (2012), Gabaix (2012), and Wachter (2012).21 To
clarify this issue, we need measures for volatility tail risks.
21
There are also a few equilibrium option models incorporating rare event risks, including Backus et al. (2011),
Benzoni et al. (2011), Du (2010), Liu et al. (2005), and Shaliastovich (2011). However, most of these studies focus
on matching empirical characteristics of S&P 500 options such as the implied volatility smirk, and none of them
investigates variance premiums.

18

Volatility-of-Volatility and Volatility Tail Risk Indices

We rst discuss empirical calculations of our proposed volatility-of-volatility and volatility tail risk
indices V IXV and V T IX. Then we investigate how these risks are priced relative to variance and
equity premiums based on return predictive regressions.

5.1

Empirical Methodology and Descriptive Statistics

We focus on a 30-day horizon for the synthetic variance swap rates written on the VIX, i.e., T

t=

30. At each day, we choose VIX options with exactly 30 days to expire if they are available.
Otherwise, two contracts with the nearest maturities of 30 days with one longer and the other
shorter than 30 days will be chosen. We keep only out-of-the-money options and exclude days with
fewer than two option quotes of dierent moneyness levels for each chosen maturity.
The computation of IV and V relies on a continuum of moneyness levels, as shown by (15)(16). Following Carr and Wu (2009) and Du and Kapadia (2012), we interpolate implied volatilities
across the range of observed moneyness levels and use the implied volatility of the lowest (highest)
available moneyness for moneyness levels below (above) it. In total, we generate 2,000 implied
volatility points equally spaced over a strike range of zero to three times the current spot price for
each chosen maturity at each date. We then obtain a 30-day implied volatility curve either exactly
or by interpolating the two implied volatility curves of the two chosen maturities. Finally, we use
the generated 30-day implied volatility curve to compute the out-of-the-money VIX option prices
by the BlackScholes formula and then IV and V according to a discretization of (15)-(16). In
addition, we compute the annualized 30-day realized variance of the VIX RV as
T t

RV =

vt+i;t+i+30
365 X
ln
T t
vt;t+30

(17)

i=1

using daily VIX levels.22

With the daily indices, we pick end-of-month quantities to make a monthly time series, extending
from March 2006 to April 2011 with 60 months in total. Panels A and B of Figure 2 provide
plots of V IXV and V T IX over our sample period, respectively. The shaded area represents the
NBER-dened recession period December 2007June 2009. It is clear from Panel A that the index
V IXV for volatility-of-volatility remains positive most of the time but becomes deeply negative
occasionally. But Panel B shows that it is the opposite case for the volatility tail index V T IX.
Furthermore, as expected, V T IX has its largest value during the recession period, much larger than
values during non-recession periods. The volatility-of-volatility index, however, has some extreme
values even during non-recession periods although reaching an extreme value during the recession
period as well.
22

We also tried ve-minute VIX series in calculating RV and found similar results.

19

For comparison, we plot in Panel C of Figure 2 the return jump and tail index JT IX
VSP

IVSP , where IVSP SP and VSP are dened similarly to IV and V in (15) and (16), respectively,

with the underlying price replaced by S&P 500 index returns. We nd the JT IX also has its
largest value during the recession period, similar to the V T IX. However, one observable large
dierence between the JT IX and V T IX is that the latter has fairly big and volatile series during
the non-recession period relative to its largest value in the recession while values of the former in
the non-recession period are substantially smaller than its peak. Finally, we plot in Panel D two
measures of variance risk premiums, i.e., IVSP

RVSP in Bollerslev et al. (2009) and VSP

RVSP

in Du and Kapadia (2012).23 The former missed price jumps while the latter incorporate them (Du
and Kapadia, 2011). Comparing Panels B and C to D suggests that time variations of variance risk
premiums track those of TIX better than temporal variations in V T IX, providing a preliminary
evidence that V T IX stands as a separate channel, while JT IX may be subsumed relative to
variability risks of returns.

5.2

Return Predictability Regressions

We now study whether measures of stochastic volatility-of-volatility and volatility tails predict
market returns as expected by (5). Then in light of (6), we investigate whether the predictability
of V IXV and V T IX are only through the variance risk premium vpt;T or present additional risks
relative to the channel of return variability.
5.2.1

Setup and Summary of Predictors

Our setup follows Bollerslev et al. (2009) and Du and Kapadia (2012) to estimate a series of
predictive regressions for market returns and control for a large set of traditional predictors. In
particular, monthly P/E and P/D ratios are obtained from Robert Shillers website, while quarterly
CAY data of Lettau and Ludvigson (2001) are downloaded from Lettau and Ludvigsons website.24
The term spread (dened as the dierence between 10-year T-bond and three-month T-bill yields),
the default spread (dened as the dierence between Moodys BAA and AAA corporate bond
spreads), the stochastically detrended risk-free rate (dened as the one-month T-bill rate minus its
backward 12-month moving average), and the three- and one-month T-bill rates are all from the
website of the Federal Reserve Bank of St. Louis.
Panel A of Table 8 reports basic summary statistics for the monthly returns and predictor
variables. The mean excess return is only -0.71% due to our short sample period containing the
recent nancial crisis. The two measures of variance risk premiums both have positive means,
with VSP

RVSP higher due to its inclusion of premiums for jump risks in market returns. The

23

I am very grateful to Jian Du and Nikunj Kapadia for sharing their data series of VSP RVSP and JT IX, which
are updated until October 2010. Moreover, the data series of IVSP RVSP are downloaded from Hao Zhous website.
24
We follow Bollerslev et al. (2009) and Du and Kapadia (2012) to use the most recent quarterly CAY data as the
monthly observations.

20

V IXV and V T IX have mean values of -0.28 and -0.09, respectively, with the former negatively and
the latter positively skewed. Panel A also reports autocorrelations of the variables up to order 3.
Consistent with the literature, all of the traditional predictors are highly persistent with rst-order
autocorrelations mostly larger than 0.9 and third-order autocorrelations still above 0.7. In contrast,
V IXV and V T IX have much lower autocorrelations. Also note that the autocorrelation of V T IX
is only one-half of that for JT IX. As a precursor for our main results, the correlation matrix in
Panel B shows that both V IXV and V T IX are fairly correlated with the market returns, while
the correlations of traditional predictors are tiny except for the CAY and RREL. Moreover, V T IX
is much less correlated with CAY, log(P/E), and log(P/D) than JT IX.
5.2.2

Results

All regressions are conducted at the monthly frequency, with one-month, three-month, six-month
and 12-month period returns. Hence, observations are overlapping for regressions of the last three
types. To account for the heteroskedasticity and autocorrelation induced by the overlapping observations, we compute all t-statistics based on the standard errors of Hodrick (1992).25 Table 9
reports results of predictive regressions for one-, three-, six-, and 12- month return horizons.26
Focusing on univariate regressions, Table 9 shows that variance risk premiums are largely signicant at all horizons we consider, consistent with the literature. And the traditional predictors
have mixed successes, with the CAY signicant at one- and two- month horizons, and the RREL
signicant up to six months. Most importantly, we nd that V IXV has signicant predictability
for short horizons of one and three months with t-statistics equal to 2.04 and 1.91, respectively.
The volatility tail index V T IX is more impressive in predicting returns, being signicant at 5%
levels up to six-month horizons. Therefore, at least for short horizons, the results show that risk
premiums associated with volatility-of-volatility and volatility tails indeed predict returns, as dictated by (5). This pattern provides further support for incorporating both stochastic volatility and
volatility jumps in consumption-based asset pricing models.
We next consider multivariate regressions by adding variance risk premiums. For the regression
with the volatility-of-volatility index, adding variance risk premiums (either IVSP

RVSP or VSP

RVSP ) makes V IXV insignicant for the three-month horizon. Even for the one-month horizon, the
t-statistic is decreased from 2.04 to 1.70. These results suggest that the predictability of V IXV for
market returns is subsumed substantially by the variance risk premiums, implying that volatilityof-volatility risk does not stand as a separate risk channel from the return variance.
In contrast, the signicance of V T IX to predict market returns survives the adding of variance
risk premiums to the regression although the t-statistics are all decreased. The only exception
is the regression of six-month horizons with IVSP
25

RVSP for which the t-statistic is -1.09. But

Ang and Bekaert (2007) illustrate by a Monte Carlo study that the Hodrick (1992) standard errors are more reliable
than the classical Newey and West (1987) standard errors for predictive regressions with overlapping observations.
Wei and Wright (2009) extend the reverse regression approach of Hodrick (1992) to the multivariate case.
26
For highly persistent predictors, the R2 of regressions has to be explained with caution.

21

even for this case, the V T IX is still signicant with the better measure of variance risk premium
VSP

RVSP . These results do not change even when we add traditional predictors, as shown in the

last three columns of Table 9. In fact, after adding log(P/D) and term premium to the regression
with V T IX and IVSP

RVSP , the V T IX becomes signicant even at the 10% level for the 12-

month horizon.27 Overall, our results suggest that the volatility tail risk presents a dierent channel
from the return variability risk and is closely associated with equity risk premiums.

5.3

Stock Return Tail vs Volatility Tail

The previous section demonstrated the economic signicance of volatility tail risks as a separate
channel. However, one may ask whether volatility tail risks are signicant only because of their
correlation with return tail risks given the evidence that jumps in volatility and price levels are
strongly dependent (Bandi and Reno, 2011 and Todorov and Tauchen, 2011). The preliminary
answer is no by the observable large dierence in time variations of the JT IX and V T IX: the
latter is more volatile during non-recession periods relative to the peak, as discussed in Section
5.1.28 We now address this concern formally by predictive regressions.
Table 10 reports both univariate return predictive regressions with JT IX and multivariate
regressions by adding variance risk premiums and V T IX to the former. The rst two columns
of each cell show that the JT IX is only signicant for the 12-month horizon individually but
achieves better signicance combining with IVSP

RVSP , consistent with Du and Kapadia (2012).

But it is more reliable to determine whether JT IX is signicant in predicting market returns as

a separate channel using VSP

RVSP that incorporates price jump risks. A comparison of the

second and third columns implies that no strong evidence exists to claim JT IX as a separate
risk from return variability. In particular, adding VSP

RVSP makes the signicance of JT IX

vanish for the six-month horizon while decreasing the t-statistic from 2.55 to 2.05 for the 12-month
horizon. Therefore, our results conrm the conclusion of Du and Kapadia (2012) that the rstorder importance of return jump risks are through their impact on market return variability, which
indirectly supports the importance of volatility jumps as a separate channel.
As direct evidence, the last column of each cell in Table 10 reports regression results with both
JT IX and V T IX. We observe that V T IX is signicant at all horizons except the 12-month period,
increasing the adjusted R2 more than 10 times that of the univariate regression with only JT IX.
It also improves the signicance of JT IX for the six-month and 12-month horizons, increasing
the t-statistics from 0.75 and 1.99 to 2.45 and 2.58, respectively. Overall, our results show that
volatility tail risks present dierent channels from both the return variance and equity tail risks.
Consequently, our volatility tail risk index V T IX is useful as an additional index for investors to
27

We exclude traditional predictors that are highly correlated with V T IX or variance premium measures to avoid
the multicolinearity problem for regressions reported in the last three columns.
28
Using S&P 500 futures high-frequency returns from 1982 to 2009, Bandi and Reno (2011) nd that the number
of estimated yearly co-jumps is 89, while that of the idiosyncratic volatility jumps is about 13.

22

gauge risks of extreme events, dierent from all equity tail risk measures proposed in Bollerslev and
Todorov (2011), Du and Kapadia (2012), and Kelly (2011).

Robustness Checks and Further Results

We conduct robustness checks for results of returns on VIX option portfolios in this section. We
also present some further results about the V T IX because of its prominent importance documented
above.

6.1

Transaction Costs of VIX Option Portfolio Strategies

It is essential to understand to what extent the transaction costs incurred by buying and selling
VIX options when employing portfolio strategies in Section 3 would aect our results.29 As our data
cleaning procedure has excluded a large set of illiquid options based on open interest and trading
volumes, we focus on the bid-ask spread here. Our results reported in Section 3 are all based on
returns computed using the mid-point of the bid and ask price quotes. We investigate this issue by
re-computing returns on all of the employed portfolios assuming the eective spread is 10%, 25%,
and 50% of the quote spread, respectively. By denition, the eective spread is equal to twice the
dierence between the true execution price and the market quote. For example, suppose the bid
and ask prices of an option are 4 and 5 dollars, respectively. Then a 50% eective spread means
that we buy the option at 4.75 while selling it at 4.25.
Table 11 reports returns of calls, zero-delta straddles, delta-hedged calls, zero-delta crash-neutral
straddles, and tail portfolios computed by an eective spread of 0% (the mid-quote), 10%, 25%,
and 50% respectively. The rst three strategies are all at the money with moneyness levels in (0.95,
1.05], while the out-of-the-money call in zero-delta crash-neutral straddles has moneyness 1.20. For
the tail portfolios, we consider options that are 15% away from the at-the-money strike. Results
of options with other characteristics including both puts and delta-hedged puts are similar and not
reported here to save space.
Observe that all of the option strategies have decreasing magnitudes of returns with respect to
the eective spread. As expected, weekly returns in Panel A are aected more than the held-untilmaturity returns on delta-hedged calls and tail portfolios in Panels B and C because the former
involves more frequent buying and selling. The most severe case is the zero-delta crash-neutral
straddle with returns increasing from -3.6% to -0.82% per week that is insignicantly dierent from
zero with a p-value at 24.63. This is not surprising given that such a portfolio involves three option
contracts. However, zero-delta crash-neutral straddles with the eective spread less than 25% and
all the other strategies are all signicant consistently as results in Section 3. Therefore, our results
29
A large literature documents the importance of transaction costs in the options markets; see Figlewski (1989) and
Ofek et al. (2004) among many others.

23

are robust to reasonable values of eective spreads although the magnitudes of option returns do
decrease after transaction costs are considered.

6.2

Daily V T IX Series

The reported V T IX series in Section 5 are only at the monthly frequency with a maturity of 30
days. Given the documented importance of the V T IX to capture risks of volatility tails and hence
extreme events, it would be important to have the index at daily frequencies and also with dierent
maturities. Figure 3 plots the daily time series of the 30-day and 45-day V T IX series in Panels
A and B, respectively. Certain days have some missing values, especially in the initial period of
20062007 when VIX options were rst introduced. We linearly interpolate them on days with
missing values.
Observe that the daily V T IX series of 30-day maturity are similar to the monthly series in
Panel B of Figure 3 except that the latter misses a spike in April 2010. The V T IX series of 45-day
maturity in Panel B, however, are smoother than the the 30-day V T IX except at peak times,
probably due to the volatility mean reversion. Unreported statistics show that both the 30-day
and 45-day V T IX series are highly persistent, with rst-order autocorrelations of 0.86 and 0.90,
respectively. More interestingly, the correlation between them is only 0.81, showing that the V T IX
may have certain distinct features across maturities. This non-perfect correlation echoes studies
favoring two factors to drive the volatility process, for example, Adrian and Rosenberg (2008) and
Christoersen et al. (2008).

Conclusion

We provide model-free evidence regarding the two leading channels in modeling volatility risks:
stochastic volatility-of-volatility and volatility jumps. We nd that risks of volatility-of-volatility
and jump-induced volatility tails are both priced. We further construct measures for volatilityof-volatility and volatility tail risks by the whole set of out-of-the-money VIX options. We nd
that both measures predict short-period market returns, with predictability from the volatilityof-volatility risk subsumed by the variance risk premium but the volatility tail risk standing as a
separate channel. Hence, dierent from existing tail risk measures of merely market returns, our
volatility tail index provides important information about how investors gauge the extreme volatility
risks.
Our results are limited to the short period from May 2006 to April 2011 when VIX options
are available. It would be important to investigate these issues and update the volatility tail index
when more data are available with further developments of the volatility market. Moreover, our
model-free results imply that asset pricing models with both stochastic volatility-of-volatility and
volatility jumps would benet from volatility option prices in deciphering the ne structure of
equity and variance risk premiums. It remains interesting to investigate the empirical performance
24

of models in Bansal et al. (2012), Bollerslev et al. (2009), Campbell et al.(2012), and Drechsler and
Yaron (2011) by adding the dimension of VIX options, especially those about the extreme volatility
risks.

25

Appendix
Proof of Proposition 1: The expected excess return of a volatility call option held until
maturity is
C
rt;T

=
=

Et (vt;T K)+
1
Et m (vt;T ) (vt;T K)+
R1
K) [1 m (v)] f (v) dv
KR (v
1
K) m (v) f (v) dv;
K (v

C with respect
where equation (7) is used in the rst equality. Taking the rst-order derivative of rt;T

to K, we have
C
drt;T

dK

R1
K

hR

(v

1
K (v

Et [(vt;T

R1
K) m (v) f (v) dv [1 F (v)]
m (v) f (v) dv
K (v
R1
2
K) m (v) f (v) dv
K (v
i hR
i hR
i
1
1
f (v)
f (v)
K) [1 f F(v)(v)] dv
m
(v)
dv
(v
K)
m
(v)
dv
K
K
[1 F (v)]
[1 F (v)]
hR
i2
1
K) m (v) [1 f F(v)(v)] dv
K (v

K) f (v) dv

R1
K

K) jvt;T > K] Et [m (vt;T ) jvt;T > K] Et [m (v) (vt;T

hR
i2
1
f (v)
(v
K)
m
(v)
dv
K
[1 F (v)]

K) jvt;T > K]

Covt [(vt;T K) ; m (vt;T ) jvt;T > K]

hR
i2 :
1
f (v)
(v
K)
m
(v)
dv
K
[1 F (v)]

Therefore, the sign of

C
drt;T
dK

is determined by the negative of the covariance between vt;T

K and

the volatility pricing kernel m (vt;T ) conditional on the option being in the money.
C will decrease in the strike K and achieves the
If m (vt;T ) is increasing in vt;T over (0; 1), rt;T

largest value when the strike is equal to zero. As the call option with a zero strike has the same
expected net return as that of the underlying volatility that is usually not larger than zero, we
conclude that all call options have negative returns given an increasing volatility pricing kernel. For
the case (ii) of a U-shaped m (vt;T ) with the threshold at K , the conclusion is the same as above
when vt;T is larger than K . However, at low strikes when vt;T is smaller than K , we will have the
C could be positive and has an increasing pattern. This nishes the proof.
opposite scenario that rt;T

Q.E.D.
Proof of Proposition 2: Similar to the derivations for expected call returns, the expected
excess return of a volatility put is
P
rt;T
=

Covt [(vt;T K) ; m (vt;T ) jvt;T < K]

:
hR
i2
K
(K
v)
m
(v)
f
(v)
dv
1
26

That is, the sign of

P
drt;T
dK

is determined by the negative of the covariance between vt;T

K and the

volatility pricing kernel m (vt;T ) conditional on the put option being in the money.
C will decrease in the strike K and achieves the
If m (vt;T ) is increasing in vt;T over (0; 1), rt;T

smallest value at an innite strike price. As the put with an innite strike has an expected net
return equal to the risk-free rate, we conclude that all put options have positive returns given an
increasing volatility pricing kernel. For the case (ii) of a U-shaped m (vt;T ) with the threshold at
K , the conclusion does not change vt;T is larger than K . However, at low strikes when vt;T is
C could be negative with a decreasing
smaller than K , we will have the opposite scenario that rt;T

pattern. Q.E.D.

27

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31

Table 1: Summary Statistics of VIX Options

Moneyness (=Strike/VIX)
0.7

0.7 0.8

0.8 0.95

0.95 1.05

1.05 1.2

1.2 1.3

1.3

Total

Call Options
# of Contracts

3,673

1,975

4,028

2,829

3,940

2,359

10,363

29,167

(%)

12.59

6.77

13.81

9.70

13.51

8.09

35.53

100

Average Volume (103 )

0.47

0.84

1.27

2.88

4.12

4.41

3.21

2.62

Open Interest (104 )

0.97

1.05

1.33

2.18

3.44

3.96

4.30

2.90

Average Price

13.88

6.77

4.48

2.84

1.82

1.17

0.55

3.64

# of Contracts

960

1,113

3,125

2,733

3,565

1,762

4,831

18,089

(%)

5.31

6.15

17.28

15.11

19.71

9.74

26.71

100

Average Volume (103 )

1.68

2.39

3.22

3.58

2.67

1.32

0.27

2.06

Open Interest (104 )

1.79

2.11

2.84

3.18

3.19

2.73

0.91

2.33

Average Price

1.07

1.14

1.42

2.15

3.65

5.70

13.40

5.55

Put Options

Notes: This table provides summary statistics for our sample (from February 2006 to April 2011) of VIX options
across seven groups of moneyness, measured as strike divided by the underlying VIX. Note that we only consider
cleaned data with maturity larger than a week and less than 60 days for liquidity concerns, with a total of 29,167
calls and 18,089 puts. We report the number of contracts, the percentage relative to the total number, average
trading volumes, average open interests, and average prices for both calls and puts.

32

Table 2: Weekly Returns of VIX Call and Put Options

Moneyness
0.75-0.85

0.85-0.95

0.95-1.05

1.05-1.15

1.15-1.25

1.25-1.35

Panel A: VIX Call Option Returns

Mean return

-4.47

-9.63

-11.54

-12.25

-16.17

-21.38

t-Statistic

(-0.96)

(-2.34)

(-3.09)

(-2.84)

(-3.88)

(-5.13)

p-value

12.06

0.99

0.07

0.19

0.00

0.00

Bootstrapped p-value

16.65

1.08

0.14

0.38

0.02

0.00

Median

-5.56

-10.88

-15.09

-15.85

-16.38

-25.64

Minimum

-70.95

-77.27

-81.11

-84.00

-87.10

-88.24

Maximum

86.73

97.92

102.94

110.53

115.05

130.14

p-value of MR test

6.38

31.48

Panel B: VIX Put Option Returns

Mean return

8.39

12.54

6.51

3.47

4.47

3.52

t-Statistic

(1.32)

(2.80)

(2.12)

(1.43)

(1.99)

(1.69)

p-value

9.50

0.20

1.76

7.51

2.32

4.64

Bootstrap p-value

8.56

0.19

1.66

7.60

2.32

4.54

Median

-13.79

-1.39

0.00

2.61

5.66

5.68

Minimum

-80.00

-78.05

-80.65

-76.19

-67.31

-58.14

Maximum

230.77

240.00

175.00

125.00

81.08

60.61

p-value of MR test

49.16

11.65

Notes: This table reports summary statistics for weekly VIX call and put returns. The sample period is March
2006 to April 2011 (269 weeks). To avoid overlapping observations, we compute weekly returns by holding a 30-day
option for one week at the weekly frequency. Six groups of moneyness are considered, ranging from 0.75 to 1.35. We
report mean, median, minimum, and maximum returns, along with conventional t-statistics and p-values based on
the standard normal distribution and bootstrapped p-values calculated by B=25,000 bootstrap draws. Moreover,
bootstrapped p-values for the MR test of Patton and Timmermann (2010) are reported with B bootstrap draws.
All of the numbers are in percentage terms except the t-statistics.

33

Table 3: Weekly Returns of Zero-Delta Straddles

Moneyness

0.85-0.95

0.95-1.05
Black-Scholes

1.05-1.15

1.15-1.25

1.25-1.35

Mean return

-9.39

-6.59

-5.16

-5.25

-5.35

t-Statistic

(-6.02)

(-3.73)

(-2.63)

(-1.53)

(-2.05)

p-value

0.00

0.01

0.45

6.28

2.10

Bootstrap p-value

0.00

0.02

0.70

7.46

2.40

Median

-8.87

-8.00

-7.02

-7.97

-8.04

Minimum

-75.00

-80.06

-82.43

-78.02

-82.83

Maximum

33.64

117.39

117.31

384.21

132.69

Setting

c =0.9*(Black-Scholes

c)

Mean return

-11.41

-7.77

-5.74

-5.91

-5.82

t-Statistic

(-7.21)

(-4.31)

(-2.84)

(-1.71)

(-2.17)

p-value

0.00

0.00

0.18

4.24

1.44

Bootstrap p-value

0.00

0.00

0.10

5.61

1.94

Setting

c =1.1*(Black-Scholes

c)

Mean return

-5.94

-5.08

-4.49

-4.60

-4.91

t-Statistic

(-3.38)

(-2.85)

(-2.32)

(-1.35)

(-1.92)

p-value

0.02

0.27

1.06

8.99

2.59

Bootstrap p-value

0.03

0.29

1.70

9.98

2.82

Notes: This table reports summary statistics for weekly returns on zero-delta straddles of VIX options. The
sample period is March 2006 to April 2011 (269 weeks). To avoid overlapping observations, we compute weekly
returns by holding a 30-day zero-delta straddle position for one week at the weekly frequency. Five groups of
moneyness are considered, ranging from 0.85 to 1.35. And

is the BlackScholes delta computed using the

implied volatility quotes of data, and we consider two levels of measurement errors for check the robustness. We
report mean, median, minimum, and maximum returns, along with conventional t-statistics and p-values based on
the standard normal distribution and bootstrapped p-values calculated by B=25,000 bootstrap draws. All of the
numbers are in percentage terms except the t-statistics.

34

Table 4: Returns of Delta-Hedged VIX Call Options Held until Maturity

Moneyness
Maturity
30 days

44 days

58 days

0.85-0.95

0.95-1.05

1.05-1.15

1.15-1.25

1.25-1.35

Mean return (%)

-17.29

-11.70

-12.44

-11.66

-11.37

t-statistic

(-5.10)

(-3.58)

(-4.12)

(-4.25)

(-2.73)

p-value (%)

0.00

0.02

0.00

0.00

0.35

Bootstrap p-value (%)

0.00

0.00

0.00

0.00

0.24

Average moneyness

0.9024

1.0011

1.1047

1.2021

1.3027

Mean return (%)

-10.53

-10.31

-8.22

-3.57

-7.07

t-statistic

(-2.74)

(-3.06)

(-2.20)

(-0.69)

(-1.66)

p-value (%)

0.31

0.08

1.49

24.59

4.96

Bootstrap p-value (%)

0.15

0.05

1.74

22.70

4.84

Average moneyness

0.9012

0.9979

1.0976

1.1938

1.3002

Mean return (%)

-23.94

-18.65

-16.12

9.03

-10.36

t-statistic

(-3.89)

(-4.00)

(-3.41)

(-1.68)

(-1.83)

p-value (%)

0.01

0.00

0.03

4.45

3.24

Bootstrap p-value (%)

0.00

0.00

0.04

6.40

3.62

Average moneyness

0.9045

1.0043

1.0986

1.1944

1.2988

Notes: This table reports summary statistics for held-until-maturity non-overlapping returns on delta-hedged
VIX calls with 30, 44, and 58 days to expire. The sample period is March 2006 to April 2011. Five groups of
moneyness are considered, ranging from 0.85 to 1.35. The values of delta used in constructing the portfolios is computed by the BlackScholes formula using implied volatility quotes of data. We report mean returns, conventional
t-statistics, and p-values based on the standard normal distribution, bootstrapped p-values calculated by B=25,000
bootstrap draws, and average moneyness in each moneyness group. All of the numbers are in percentage terms
except the t-statistics and average moneyness.

35

Table 5: Returns of Delta-Hedged VIX Put Options Held until Maturity

Moneyness
Maturity
30 days

44 days

58 days

0.85-0.95

0.95-1.05

1.05-1.15

1.15-1.25

1.25-1.35

Mean return (%)

-24.77

-11.01

-8.49

3.84

12.23

t-statistic

(-2.22)

(-1.50)

(-1.15)

(0.68)

(1.95)

p-value (%)

1.38

6.42

12.53

25.29

2.38

Bootstrap p-value (%)

0.84

6.00

12.17

24.30

2.36

Average moneyness

0.9034

0.9998

1.0990

1.1959

1.2949

Mean return (%)

-33.84

-18.03

-20.37

-2.78

-12.18

t-statistic

(-1.26)

(-1.71)

(-1.48)

(-0.23)

(-0.61)

p-value (%)

10.36

4.25

6.64

40.61

27.39

Bootstrap p-value (%)

8.59

3.28

5.20

40.80

28.17

Average moneyness

0.9012

0.9957

1.0963

1.2004

1.2960

Mean return (%)

-43.19

-32.94

-17.59

-0.69

-2.47

t-statistic

(-3.11)

(-3.29)

(-2.28)

(-0.11)

(-0.31)

p-value (%)

0.05

0.04

1.16

45.71

37.60

Bootstrap p-value (%)

0.00

0.00

0.65

48.30

39.21

Average moneyness

0.9025

1.0008

1.0964

1.1961

1.2968

Notes: This table reports summary statistics for held-until-maturity non-overlapping returns on delta-hedged
VIX puts with 30, 44, and 58 days to expire. The sample period is March 2006 to April 2011. Five groups of
moneyness are considered, ranging from 0.85 to 1.35. The values of delta used in constructing the portfolios is computed by the BlackScholes formula using implied volatility quotes of data. We report mean returns, conventional
t-statistics, and p-values based on the standard normal distribution, bootstrapped p-values calculated by B=25,000
bootstrap draws, and average moneyness in each moneyness group. All of the numbers are in percentage terms
except the t-statistics and average moneyness.

36

Table 6: Weekly Returns of Zero-Delta, Crash-Neutral Straddles

OTM Call Moneyness

1.10

1.15

1.20

1.25

1.30

Mean return (%)

-2.94

-3.34

-3.60

-3.65

-3.96

t-Statistic

(-2.53)

(-2.89)

(-3.15)

(-3.14)

(-3.33)

p-value (%)

0.63

0.20

0.07

0.10

0.05

Bootstrapped

0.62

0.20

0.10

0.11

0.04

1.0017

1.0023

1.0023

1.0023

1.0023

1.0974

1.1535

1.2060

1.2543

1.3026

p-value (%)
Average ATM Call
Moneyness
Average OTM Call
Moneyness
Notes: This table reports summary statistics for weekly returns on zero-delta crash-neutral straddles of VIX
options. The sample period is March 2006 to April 2011 (269 weeks). To avoid overlapping observations, we compute
weekly returns by holding a 30-day zero-delta crash-neutral straddle position for one week at the weekly frequency.
Five levels of moneyness for the out-of-the-money call in the portfolio are considered, ranging from 1.10 to 1.30.
The values of delta used in constructing the portfolios is computed by the BlackScholes formula using implied
volatility quotes of data. We report mean returns, conventional t-statistics, and p-values based on the standard
normal distribution, bootstrapped p-values calculated by B=25,000 bootstrap draws, and average moneyness for
both at-the-money and out-of-the-money calls. All of the numbers are in percentage terms except the t-statistics
and average moneyness levels.

37

Table 7: Returns on Tail Portfolios

Panel A: LR-Tail Portfolio
Mean

t-Statistic

p-value

Bootstrapped p-value

return

OTM

VIX

Average OTM

Average OTM

Put Position

Position

Put Moneyness

Call Moneyness

L: 0.85, R: 1.15

90.53

(1.52)

6.17

5.61

-1.1404

-0.8118

0.8573

1.1626

L: 0.75, R: 1.25

220.28

(2.62)

0.45

0.25

-1.2880

-0.6438

0.7410

1.2482

Mean

t-Statistic

p-value

Bootstrapped p-value

ATM

VIX

Average ATM

Average OTM

Put Position

Position

Put Moneyness

Put Moneyness

2.50

0.6986

0.4098

0.9875

0.8515

0.02

0.5740

0.2969

0.9911

0.7534

ATM

VIX

Average ATM

Average OTM

Call Position

Position

Call Moneyness

Call Moneyness

Panel B: L-Tail Portfolio

return
L: 0.85

9.90

(1.88)

2.89

L: 0.75

17.80

(3.76)

0.01

Panel C: R-Tail Portfolio

Mean

t-Statistic

p-value

Bootstrapped p-value

return
R: 1.15

31.19

(10.51)

0.00

0.00

-0.9705

0.1733

0.9935

1.1522

R: 1.25

39.65

(13.55)

0.00

0.00

-0.8965

0.2094

0.9965

1.2504

Notes: This table reports summary statistics for held-until-maturity non-overlapping returns on tail portfolios of VIX options with 30 days to expire. The sample period
is March 2006 to April 2011. We consider L-Tail, R-Tail, and LR-Tail portfolios with options away-from-the-money at both 15% and 25% levels. The values of delta used
in constructing the portfolios is computed by the BlackScholes formula using implied volatility quotes of data. We report mean returns, conventional t-statistics, and
p-values based on the standard normal distribution, bootstrapped p-values calculated by B=25,000 bootstrap draws, positions of the options and underlying VIX, and average
moneyness levels. All of the numbers are in percentage terms except the t-statistics, positions, average moneyness.

38

Table 8: Summary Statistics of Predictors

Panel A : Summary Statistics
Rmt -Rft

IVSP -RVSP

VSP -RVSP

VIXV

VTIX

JTIX

DEF

TERM

RREL

CAY

log(P/D)

log(P/E)

Mean

-0.0071

0.0169

0.0323

-0.2836

-0.0926

0.0061

0.0538

0.0197

-0.0041

-0.0261

1.6791

1.3353

Std

0.6344

0.0317

0.0365

0.9144

0.0952

0.0116

0.0036

0.0141

0.0084

0.0093

0.0898

0.0844

Median

0.1098

0.0165

0.0259

-0.0079

-0.1043

0.0026

0.0539

0.0240

-0.0009

-0.0288

1.7059

1.3502

Max

1.0755

0.0818

0.1295

0.8246

0.2828

0.0581

0.0628

0.0369

0.0102

-0.0041

1.7664

1.4400

Min

-2.2385

-0.1807

-0.1132

-4.2000

-0.2736

0.0003

0.0449

-0.0038

-0.0255

-0.0375

1.4367

1.1245

Skew

-0.9758

-0.3816

-0.2479

-1.8898

1.2739

3.3436

-0.2258

-0.4665

-0.6378

1.1985

-1.2759

-0.6928

Kurt

4.4067

26.7976

7.3209

7.6864

6.5598

14.0993

3.3651

1.6432

2.8852

3.5546

3.5036

2.6098

AR(1)

0.3027

0.1793

0.2467

0.2299

0.4593

0.7475

0.8066

0.9618

0.9198

0.8800

0.9583

0.9610

AR(2)

-0.0371

0.2032

0.4552

-0.1597

0.2108

0.4250

0.5900

0.9163

0.8329

0.7539

0.8946

0.9050

AR(3)

0.1946

-0.0223

0.1881

-0.0354

0.2467

0.3027

0.4676

0.8692

0.7621

0.6276

0.8221

0.8498

Rmt -Rft

IVSP -RVSP

VSP -RVSP

VIXV

VTIX

JTIX

DEF

TERM

RREL

CAY

log(P/D)

log(P/E)

1.00

0.32

0.24

0.24

-0.30

-0.13

-0.19

0.03

0.31

-0.37

-0.01

-0.10

1.00

0.89

0.37

-0.30

-0.34

-0.45

0.18

0.15

-0.18

-0.13

-0.20

0.26

-0.07

0.10

-0.39

0.41

-0.03

0.14

-0.49

-0.54

1.00

-0.42

-0.27

-0.31

0.09

0.10

-0.17

-0.03

-0.08

1.00

0.40

0.46

-0.09

-0.41

0.51

-0.33

-0.15

Panel B: Correlation Matrix

Rmt -Rft
IVSP -RVSP
VSP -RVSP
VIXV
VTIX

1.00

JTIX

1.00

DEF
TERM
RREL
CAY
log(P/D)
log(P/E)

0.25

0.34

-0.39

0.67

-0.68

-0.63

1.00

-0.36

-0.26

0.40

-0.08

0.17

1.00

-0.24

0.15

-0.48

-0.71

1.00

-0.55

0.44

0.28

1.00

-0.67

-0.52

1.00

0.93
1.00

Notes: This table reports summary statistics of the predictors used in predictive regressions, with basic statistics in Panel A, including mean, standard deviation, median,
minimum, maximum, skewness, kurtosis, and autocorrelations of order 3, and the correlation matrix in Panel B. Rmt -Rft is the excess market return, IVSP -RVSP is the
variance premium from Hao Zhous website, VSP -RVSP and JTIX are the variance premium and tail measures in Du and Kapadia (2012), VIXV is our measure for volatility
of volatility, VTIX is our volatility tail index, DEF is the dierence between Moodys BAA and AAA bond yields, TERM is the dierence between 10-year and three-month
Treasury rates, RREL is the detrended risk-free rate, CAY is the consumption-wealth ratio of Lettau and Ludvigson (2001), and log(P/D) and log(P/E) are log price-dividend
and price-earnings ratios on S&P 500 index, respectively. The sample period is May 2006 to April 2011 except for VSP -RVSP and JTIX available until October 2010.

39

Table 9: Return Prediction with VTIX

Panel A: 1-Month Return Prediction
Const

0.94

0.46

-0.67

0.07

-0.03

1.53

-0.20

0.05

-0.18

-0.11

-0.06

-0.24

-0.10

-0.33

-0.22

1.03

2.28

(0.68)

(0.24)

(-1.73)

(0.89)

(-0.42)

(1.18)

(-1.78)

(0.53)

(-1.61)

(-1.16)

(-0.81)

(-1.82)

(-0.81)

(-2.29)

(-1.83)

(0.44)

(1.17)

0.64

0.53

0.49

0.49

0.46

0.43

(2.16)

(3.06)

(1.71)

(1.65)

(1.69)

(1.68)

IVSP -RVSP
VSP -RVSP

4.29
(1.74)

VIXV
VTIX

3.39

3.92

(1.82)

(1.80)

0.17

0.10

0.14

(2.04)

(1.70)

(2.06)

-2.18

-1.65

-2.05

-1.65

-1.93

-2.04

(-2.98)

(-1.94)

(-2.20)

(-1.94)

(-2.19)

(-1.72)

-0.14

-1.11

-3.45

-8.77

(0.03)

(-0.24)

(-0.59)

(-1.26)

DEF

-20.87
(-1.21)

TERM
RREL

22.47
(2.59)

CAY

-25.34
(-1.90)

log(P/D)
log(P/E)

-0.30

-0.73

(-0.27)

(-0.53)

-0.78

-1.78

(-0.71)
Adj.R2

0.85

(-1.29)
1.79

10.47

7.10

1.96

0.36

8.48

4.33

40

3.87

8.54

8.77

12.29

5.66

10.60

10.75

9.79

11.60

Panel B: 3-Month Return Prediction

Const

1.21

0.90

-0.58

0.05

-0.03

2.70

-0.14

0.02

-0.19

-0.11

-0.09

-0.18

-0.16

-0.28

-0.15

1.51

3.12

(0.95)

(0.52)

(-1.59)

(0.74)

(-0.36)

(1.83)

(-1.14)

(0.29)

(-1.78)

(-1.05)

(-0.90)

(-1.30)

(-1.63)

(-1.83)

(-1.22)

(0.75)

(2.59)

0.58

0.54

0.49

0.50

0.46

0.43

(2.37)

(2.19)

(2.30)

(2.19)

(1.88)

(2.34)

IVSP -RVSP
VSP -RVSP
VIXV
VTIX

4.43

4.14

4.27

(2.76)

(2.59)

(2.63)

0.11

0.04

(1.91)

(0.69)

0.05
(0.72)

-1.54

-1.01

-1.23

-0.98

-1.31

-1.41

(-1.99)

(-1.66)

(-1.89)

(-0.61)

(-2.04)

(-2.22)

-1.13

-1.79

-5.11

-12.29

(-0.23)

(-0.36)

(-0.84)

(-2.58)

DEF

-50.27
(-1.84)

TERM
RREL

21.46
(2.36)

CAY

-21.32
(-1.72)

log(P/D)
log(P/E)
Adj.R2

-0.57

-0.96

(-0.56)

(-0.84)

-0.91

-2.32

(-0.98)

(-2.69)

1.42

0.58

17.68

16.55

1.90

9.44

9.01

3.54

41

12.06

16.52

15.57

19.01

11.16

16.92

17.81

18.68

24.91

Panel C: 6-month Return Prediction

Const

2.05

1.91

-0.23

0.03

-0.07

2.12

-0.11

-0.01

-0.18

-0.08

-0.09

-0.13

-0.19

-0.23

-0.15

2.99

4.97

(2.00)

(1.39)

(-0.68)

(0.53)

(-0.81)

(1.75)

(-0.98)

(-0.12)

(-1.78)

(-0.83)

(-0.94)

(-1.01)

(-1.93)

(-1.68)

(-1.23)

(1.76)

(2.83)

IVSP -RVSP
VSP -RVSP

0.36

0.37

0.29

0.28

0.22

0.17

(2.39)

(2.59)

(2.61)

(2.38)

(1.75)

(1.35)

3.90
(3.11)

VIXV
VTIX

3.96

3.80

(3.19)

(3.06)

0.03

-0.01

-0.01

(0.94)

(-0.49)

(-0.19)

-1.06

-0.73

-0.66

-0.73

-1.29

-1.30

(-2.56)

(-1.09)

(-1.83)

(-1.11)

(-2.42)

(-2.16)

0.23

0.99

5.81

-16.14

(0.05)

(0.20)

(-0.89)

(-1.95)

DEF

-39.76
(-1.77)

TERM
RREL

18.86
(1.85)

CAY

-6.89
(-0.59)

log(P/D)
log(P/E)

-1.18

-1.82

(1.48)

(-1.89)

-1.55

-3.62

(-2.08)
Adj.R2

12.25

(-2.93)
7.69

1.00

19.77

2.17

5.95

5.32

1.13

42

13.83

8.63

6.97

9.83

11.95

14.75

8.17

18.49

36.10

Panel D: 12-Month Return Prediction

Const

2.20

2.36

0.04

0.00

-0.14

0.51

-0.06

-0.04

-0.16

-0.08

-0.06

-0.07

-0.16

-0.16

-0.17

2.44

3.62

(2.48)

(2.40)

(0.18)

(0.02)

(-1.51)

(1.35)

(-0.57)

(-0.47)

(-1.47)

(-0.78)

(-0.70)

(-0.66)

(-1.54)

(-1.28)

(-1.46)

(2.55)

(3.05)

IVSP -RVSP
VSP -RVSP

0.15

0.13

0.15

0.11

0.05

0.02

(1.67)

(1.69)

(2.07)

(1.62)

(0.70)

(0.27)

2.81
(3.44)

VIXV
VTIX

2.82

2.82

(3.36)

(3.36)

0.05

0.02

-0.00

(1.39)

(0.93)

(-0.11)

-0.17

0.01

0.10

-0.11

-0.53

-0.56

(-0.36)

(0.03)

(0.23)

(-0.27)

(-1.71)

(-1.41)

4.44

5.44

-0.68

-7.44

(0.99)

(1.37)

(-0.19)

(-1.54)

DEF

-10.69
(-1.33)

TERM
RREL

13.54
(1.45)

CAY

5.21
(0.68)

log(P/D)
log(P/E)

-1.47

-1.52

(-2.49)

(-2.67)

-1.69

-2.69

(-2.54)
Adj.R2

34.69

(-3.05)
29.18

1.24

20.69

2.67

1.39

0.36

0.15

15.01

1.92

0.14

4.02

12.83

12.95

6.78

22.02

40.68

Notes: This table reports results of return predictive regressions for horizons of 1, 3, 6, and 12 months in Panels A, B, C, and D, respectively. All regressions are based
on monthly observations. Hodrick (1992) t-statistics are reported under in parentheses under the coe cient estimates. The sample period extends from May 2006 to April
2011 except that it is from May 2006 to October 2010 for regressions with VSP -RVSP and JTIX due to data limitations. All of the variables are as dened in Table 8 of the
summary statistics.

43

Table 10: Predicting Returns with JTIX and VTIX

1-Month
Const
JTIX

3-Month

12-month

0.01

-0.13

-0.13

-0.21

-0.01

-0.13

-0.15

-0.14

-0.10

-0.19

-0.21

-0.22

-0.14

-0.19

-0.21

-0.18

(0.09)

(-1.07)

(-1.05)

(-1.48)

(-0.13)

(-1.25)

(-1.43)

(-1.09)

(-1.09)

(-1.92)

(-2.01)

(-1.90)

(-1.38)

(-1.74)

(-1.82)

(-1.60)

-7.27

-1.41

-8.71

-0.67

-5.76

-0.72

-7.30

-2.03

5.77

9.87

4.53

9.69

8.63

11.11

7.73

10.09

(-0.79)

(-0.12)

(-0.81)

(-0.06)

(-0.55)

(-0.07)

(-0.71)

(-0.18)

(0.75)

(2.44)

(0.68)

(2.45)

(1.99)

(2.55)

(2.05)

(2.58)

IVSP -RVSP

0.61

0.53

0.43

0.27

(1.88)

(2.50)

(3.08)

(3.34)

VSP -RVSP

4.57

4.67

0.29

6.49

4.37

3.74

(2.71)

(1.69)
VTIX
Adj.R2

6-month

2.51

(3.00)

(3.37)

-2.07

-1.21

-1.28

-0.51

(-2.25)

(-1.72)

(-2.29)

(-1.51)

5.33

0.35

13.39

14.10

3.82

1.56

14.27

14.24

8.34

15.18

25.01

27.16

15.85

Notes: This table reports results of return predictive regressions for horizons of 1, 3, 6, and 12 months with JTIX and VTIX. All regressions are based on monthly
observations. Hodrick (1992) t-statistics are reported in parentheses under the coe cient estimates. The sample period extends from May 2006 to October 2010. All of the
variables are as dened in Table 8 of the summary statistics.

44

Table 11: Robustness Checks

Panel A: Weekly Returns

Calls

Zero-Delta Straddles

Zero-Delta Crash Neutral Straddles

Eective Spread

0%

10%

25%

50%

Mean return

-11.54

-10.89

-9.89

-8.19

Bootstrapped p-value

0.01

0.04

0.70

2.12

Mean return

-6.59

-6.55

-6.48

-6.37

Bootstrap p-value

0.02

0.03

0.02

0.04

Mean return

-3.60

-3.05

-2.22

-0.82

Bootstrapped p-value

0.10

0.44

2.94

24.63

Panel B: Delta-hedged Calls

30 days

44 days

58 days

Mean return

-11.70

-11.62

-11.48

-11.27

Bootstrap p-value

0.00

0.00

0.00

0.00

Mean return

-10.31

-10.19

-10.02

-9.74

Bootstrap p-value

0.05

0.09

0.10

0.14

Mean return

-18.65

-18.51

-18.31

-17.96

Bootstrap p-value

0.00

0.00

0.00

0.04

Mean return

90.53

88.61

85.78

81.25

Bootstrap p-value

5.61

6.18

6.48

7.19

Mean return

9.90

9.65

9.30

8.73

Bootstrap p-value

2.50

3.33

3.10

4.10

Mean return

31.19

30.08

28.46

25.87

Bootstrap p-value

0.00

0.00

0.00

0.00

Panel C: Tail Portfolios

LR-Tail Portfolio L: 0.85, R: 1.15

L-Tail Portfolio L: 0.85

R-Tail Portfolio R: 1.15

Notes: This table reports VIX option returns with eective spreads of 10%, 25%, and 30%. The returns on calls and
straddles are in weekly percentage terms, by holding the 30-day portfolios for one week at the daily frequency, while others
are computed by holding constant-maturity portfolios until maturity. The sample period is March 2006 to April 2011. Calls,
zero-delta straddles, and delta-hedged calls are at-the-money, while the out-of-the-money call in zero-delta crash-neutral
straddles has moneyness 1.20. Tail portfolios contain options 15% away from the at-the-money strike. The values of delta
used in constructing the portfolios is computed by the Black-Scholes formula using implied volatility quotes of data. We
report mean returns and bootstrapped p-values by B=25,000 draws.

45

Figure 1: Time Series of the Spot VIX and VIX Futures Prices
Panel A: VIX Index and Futures from February 2006 to April 2011
90
VIX Future
VIX Index
80

70

VIX Index and Future

60

50

40

30

20

10

-10
2006

2007

2008

2009

2010

2011

2012

Paenl B: VIX Index from January 1990 to April 2011

90

80

70

VIX Index

60

50

40

30

20

10

-10
1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

Notes: Panel A plots daily time series of VIX index and 30-day VIX future prices from February 27, 2006, to
April 29, 2011. Panel B plots the historical VIX from January 2, 2006, to April 29, 2011 to put our sample period
(March 2006 to April 2011) in historical perspective. The shaded area represent NBER-dened recessions of July
1990 to March 1991, March 2001 to November 2001, and December 2007 to June 2009.

46

Figure 2: Time Series of VIXV, VTIX, JTIX, and Variance Premiums

Panel A: VIXV from May 2006 to April 2011
0.02

x 10

Panel B: VTIX from May 2006 to April 2011

-3

0.01

VTIX

VIXV

-0.01

-0.02

-1
-0.03

-2

-0.04

-0.05
2006

2007

2008

2009

2010

2011

-3
2006

2012

2007

2008

2009

2010

2011

2012

Panel D: Variance Risk Premiums from May 2006 to October 2010

Panel C: JTIX from May 2006 to October 2010

0.15

0.06

IV
V

SP

SP

-RV

-RV

SP

SP

0.1

-RV

SP

0.05

0.05

) and (V

0.03

(IV

SP

0.02

0.01

0
2006

-0.05

-RV

SP

JTIX

SP

0.04

-0.1

-0.15

2007

2008

2009

2010

-0.2
2006

2011

2007

2008

2009

2010

2011

Notes: This gure plots monthly time series of VIXV in Panel A, VTIX in Panel B, JTIX in Panel C, and
two variance premium measures IVSP -RVSP and VSP -RVSP in Panel D. The rst two extend from May 2006 to
April 2011, while the last two extend from May 2006 to October 2010 because of data limitations. The shaded area
represents the NBER-dened recession of December 2007 to June 2009.

47

Figure 3: Daily Time Series of VTIX

x 10

Panel A: Daily VTIX for 30-Day Maturity

-3

VTIX

-2

-4
2006

2007

2008

2009

2010

2011

2012

Panel B: Daily VT IX for 45-Day M aturity

0.03

0.025

0.02

VTIX

0.015

0.01

0.005

-0.005
2006

2007

2008

2009

2010

2011

2012

Notes: This gure plots daily VTIX time series of 30-day and 45-day maturities in Panels A and B, respectively.
The sample extends from May 2006 to April 2011. The shaded area represents the NBER-dened recession of
December 2007 to June 2009.

48