Volatility Trading: How the VIX Is Built, Why VXX Decays, and What the Risk Premium Really Pays

Volatility trading means taking a position on how far prices will move. The VIX is the best-known gauge, and the products built on it are among the most misunderstood in retail investing. This guide covers how Cboe constructs the index, why the futures that funds actually hold behave differently from it, what happened to volatility products in 2018, and what the record shows about the gap between implied and realized volatility.

Buying puts to protect a portfolio is a separate subject with different trade-offs, covered in our tail risk hedging guide. Straddles, spreads, and earnings-related volatility crush are covered in our options trading guide. This guide is about the volatility products and the premium itself. Index and fund data are from Cboe and Nasdaq as of September 29, 2026 unless noted.

How the VIX is built

Cboe's methodology says the VIX estimates expected volatility by aggregating the weighted prices of S&P 500 puts and calls over a wide range of strikes. In practice:

• It uses out-of-the-money SPX options and end-of-week SPXW options in two expirations that bracket 30 days, then interpolates between them to a constant 30-day maturity.
• It takes each option's price as the midpoint of the bid and ask, and it includes only options that have a bid. It stops adding strikes once two consecutive strikes have no bid.
• Each strike is weighted by the strike spacing divided by the square of the strike, so far out-of-the-money puts carry weight even though they are cheap. The result is a variance estimate; the index is the square root, times 100.

The VIX says nothing about the direction of the S&P 500. Because low-strike puts feed into it, it rises when investors pay up for downside protection, which is why it usually climbs when stocks fall.

The number reads as a one-standard-deviation move: 16.04 on September 29, 2026 implies about 4.6% over a month (16.04 divided by the square root of 12), if you treat it as the market's estimate of the coming month.

The term structure on September 29, 2026

Cboe publishes VIX versions for other horizons, and the settlement prices of VIX futures fill in the curve:

Sources: Cboe VIX history, VIX3M, VIX6M, VIX9D, and Cboe's VX settlement file for the October contract and the others in the same folder.

An upward-sloping curve like this one is called contango. It is the normal shape: VIX3M closed above the VIX on 92% of the days from September 2009 through September 2026. It flips into backwardation, with short-dated volatility above long-dated, during sell-offs. In our reconstruction from Cboe's settlement files, the second-month future settled above the first-month future on 83% of trading days since January 2018, and the gap between them averaged 5.3% across all days.

Why VIX futures products decay

A futures contract converges to the index at expiry. If the VIX stays at 16.04 and the October future is at 17.68, that contract must lose 1.64 points, or 9.26%, by October 21. A fund tracking short-term VIX futures holds a rolling mix of the first and second months, sells the near contract as it approaches expiry, and buys the next. It earns or loses whatever the futures do, and in contango the futures drift down toward the index.

Illustration (ours): the monthly loss if the VIX does not move.

This is before fees and assumes the VIX stays where it is, which it rarely does, so the figure is a reference rather than a forecast. What it shows is that a long position in these products is a bet that volatility rises fast enough to outrun the drift, roughly 0.4% for each calendar day held at the September 29 spread.

VXX and UVXY in the record

VXX is an exchange-traded note that tracks the S&P 500 VIX Short-Term Futures Index. UVXY is a ProShares fund that seeks 1.5 times the daily performance of the same index, and ProShares states on its fund page that it "can be expected to perform very differently from 1.5x the VIX." Both have done exactly that.

Using Nasdaq's split-adjusted closing prices, VXX fell from 1,744.64 on January 18, 2018 to 17.45 on September 29, 2026. That is a loss of 99.0%, or 41.1% a year, while the VIX itself rose from 12.22 to 16.04. UVXY fell from 99,500 on September 18, 2018 to 16.99, a loss of 99.98%. Both series are adjusted for reverse splits, which change the share price but not an investor's return.

VXX had two positive periods out of nine and UVXY one. Even in 2020, when the VIX hit 82.69 on March 16, UVXY finished the calendar year down 17% because the spike came and went within weeks.

To check that the decay comes from the futures and not from a fund's structure, we rebuilt a rolling first-and-second-month portfolio from Cboe's daily VX settlements since January 18, 2018, weighting the first and second months by business days remaining to expiry. It lost 99.3% over the period, or 43.1% a year, with calendar-year results within about three points of VXX in every year. This is our approximation, not the official index, but it points to the same source of decay.

When the products do work

The same record shows why traders keep using them. In the 12 months since 2018 when the S&P 500 fell more than 5% (measured month-end to month-end), VXX rose in 11 and averaged +25%. March 2020 brought +103%, and December 2018 +36%. The exception was December 2022, when VXX fell 5.4% while the S&P 500 lost 5.9%.

The catch is timing. Over all 104 full months since 2018, VXX rose in only 36. A holder who waits for the sell-off pays roughly 5% to 9% a month while waiting, and buying after a spike gives up much of the gain, as 2020 shows: the VIX peaked in March, yet UVXY ended the year down 17%. That is why we treat these funds as short-term trading tools for a view with a date attached, and not as a portfolio hedge. Sizing matters more than the entry: a position you would be unhappy to see lose 70% in a year is too large for a holding period of a year.

February 5, 2018: XIV

XIV sat on the opposite side. Credit Suisse's exchange-traded note paid the inverse of the daily return on short-term VIX futures, so it gained from the same contango drift that hurt VXX. On February 2, 2018 its closing indicative value was $108.3681, according to Credit Suisse's notice to investors filed with the SEC.

On Monday, February 5, the S&P 500 fell 4.1% (from 2,762.13 to 2,648.94), the VIX rose from 17.31 to 37.32, and the first-month future settled at 33.225 against 15.625 on Friday, a rise of 113%. Because the note's exposure was the reverse of that, its intraday indicative value fell to 20% or less of the prior day's closing value. The notice states that this triggered an acceleration event, and Credit Suisse announced on February 6 that it would redeem the notes, with the last day of trading expected to be February 20, 2018. Holders received the closing indicative value on the accelerated valuation date, expected to be February 15.

An inverse product that resets daily can lose nearly all of its value in a day when the underlying doubles, and the sponsor can end it. Our leveraged and inverse ETF guide explains the daily reset math behind it.

The volatility risk premium

Selling volatility is attractive because implied volatility usually exceeds the volatility that follows. We tested it with Cboe's daily data by comparing the VIX with the annualized realized volatility of S&P 500 daily closes over the next 21 trading days, sampled every 21 days from 1990 to September 2026.

The premium held in most windows and in most years, including 2017 (VIX 10.8 against realized 6.6) and 2025 (19.1 against 15.6). It failed in the crises. In the window starting March 10, 2020 the VIX was 47.3 and the S&P 500 realized about 93. In the window starting October 2, 2008, 45.3 against 83.0. That pattern of many small gains and occasional large losses is the same in every strategy that sells volatility, from covered calls to short strangles to inverse volatility ETPs.

Cboe's own research gives a long-run view of a disciplined seller. Oleg Bondarenko's 2019 study found that the PutWrite index (PUT), which sells at-the-money one-month S&P 500 puts against Treasury collateral, compounded at 9.54% a year from June 1986 to December 2018 with a standard deviation of 9.95%, against 9.80% and 14.93% for the S&P 500. The premium mostly paid for lower risk at the same return, and a large drawdown in 2008 was part of the record: its maximum drawdown was 32.7% against 50.9% for the S&P 500.

The premium is not free money. It is compensation for taking losses in bad markets, and the strategy that harvests it needs a position size that survives a month like March 2020.

Choosing an instrument

A short checklist before trading volatility

1. Compare the front-month future with the VIX. At the September 29 spread of 10.2% (17.68 against 16.04), a long position starts with a headwind of about 0.4% a day.
2. Set the holding period before you buy, and sell when it ends. A holder who owns a decaying product without a date is speculating on the calendar.
3. For a short-volatility position, size it so that a day like February 5, 2018, when the front future doubled, cannot end the account.
4. Do not compare a fund's history with the VIX chart. The two tell different stories, and the fund is the one you own.
5. Consider whether a simple alternative, such as holding fewer stocks, does the job at no cost.

This guide is for informational purposes only and is not investment, tax, or legal advice. Volatility products can lose most or all of their value quickly. Figures for VXX and UVXY are split-adjusted closing prices; our futures reconstruction is an approximation. Data as of September 29, 2026. Consult a qualified adviser before trading derivatives.