Spiking the Volatility Punch

Peter Carr and Gianna Figà-Talamanca

Applied Mathematical Finance, 2020, vol. 27, issue 6, 495-520

Abstract: An alternative volatility index called SPIKES has been recently introduced. Like VIX, SPIKES aims to forecast S&P 500 volatility over a 30-day horizon and both indexes are based on the same theoretical formula; yet, they differ in several ways. While some differences are introduced in response to the controversy surrounding possible VIX manipulation, others are due to the choice of the S&P500 exchange-traded fund (ETF), named SPY, as a substitute for the S&P500 (SPX) Index itself. Indeed, options on the SPX, used for VIX computation, are European-style, whereas options on the SPY ETF, used for SPIKES computation, are American-style.Overall, the difference is mainly due to the early exercise premium of the component options and the dividend timing of the underlying SPY versus SPX and we assess the magnitude of these separate contributions under the benchmark Black, Merton and Scholes setting. By applying both the finite difference method and newly-derived approximation formulas we show that the new SPIKES index will track the VIX index as long as 30-day US interest rates and annualized dividend yields continue to be range-bound between 0 and 10% per year. Hence, after more that 20 years of supremacy, VIX may have found its first competitor.

Date: 2020
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DOI: 10.1080/1350486X.2021.1893196

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