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I cannot wrap my head around how do the VIX options work. For example SPY, simple and easy, there is a basket of stocks, and when you buy one share of SPY you own a little piece of every of 500 blue chips. If you buy options for SPY, you have a 100 X leverage of that 500 blue chip basket. Simple.

Now, VIX....there is no basket behind it. When I buy 1 option contract (not future, but option), then what exactly happens behind the scenes? What does the CBOE do when they receive money I paid for one option of VIX?

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When you purchase an option, the seller receives the money you paid for the option. The CBOE is not involved in the transaction. The calculation of the VIX index is a complicated one.

A general description is available from Investopedia:

What Is the CBOE Volatility Index (VIX)?

Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market's expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors' sentiments. It is also known by other names like "Fear Gauge" or "Fear Index." Investors, research analysts and portfolio managers look to VIX values as a way to measure market risk, fear and stress before they take investment decisions.

An explanation of the calculation of the VIX is available from the CBOE.

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  • if i understand it correctly, this is purely a bet between the buyer and the seller. There is no "excising or assignment". Buyer bets that the CBOE calculates VIX option to go UP, and seller bets that CBOE calculates the VIX go down. Right??? – user102842 Sep 26 '20 at 18:38
  • Yes, it's a 100% bet masquerading as something to do with the markets. – Fattie Sep 26 '20 at 19:14
  • All options involve a bet between the buyer and the sellers, regardless of what the underlying is. Not only is there no excising but there's no exorcising either. VIX options are European style which means that they can be exercised only at expiration and not before that. They are cash settled. – Bob Baerker Sep 26 '20 at 19:55
  • Is there a typo in your comment? Re: "excising", "exorcising". – Flux Sep 27 '20 at 2:51

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