VIX options are something I deal with a lot. They have a few wrinkles in them that a trader must be aware of.
European Style
The first thing is that they are European expiration style options. Since the VIX options are European style, pricing of these options is not based on the Black-Scholes method of pricing, but rather based on what will likely happen. For example if the VIX is at what investors believe to be an abnormally high level, the price of calls (bullish bets) will be quite cheap, while the price of puts (bearish bets) will be expensive. This is so because investors are betting the index will fall by the time the options are set to expire.
The above would not work with American style options because for example, if the VIX was at 40 and the 35 strike calls were selling at $2, someone could just buy the calls and exercise them upon purchase for a $3 profit. In the case of European style options like the VIX, this is not possible, as you can only exercise options at the date of expiry.
The Underlying
The other major thing to consider is that the options on VIX are based on the corresponding underlying future price at expiration. For example, the VIX index right now is 11.80. The July 12 puts are .05/.10. So, it would stand to reason that you would buy the put at .10, buy the VIX at 11.80 and immediately exercise the put for a .10 profit.
Bottom Line
We already know that we cannot do that because of the European style of expiration but also because the July future is trading 14.75. July options expire into July future’s settlement price. Even if VIX were American style expiration, there would be no arbitrage opportunity.
