So how do you guys price options on volatility (VIX)? VIX is pretty much a volatility index so the current volatility IMPLIED from option prices and not some future on it.
What formula do you use? By my knowledge is some Black model using futures on VIX and as far as I tested it fits the observed option prices pretty well.
But for funk's sake! Black-(Scholes) model assumes the underlier is a stock, hence it follows a geometric Brownian motion process with ANY price possible in the future. Almost zero or almost infinite and staying there that is.
Which is obviously completely off from the dynamics of a volatility underlier which is a mean reverting process.
Hence as an exercise in exercising my understanding of the market processes, I tried to produce a "correct" formula, using the correct underlier (variance) instead of some stock-based hack.
You can access it here, it's work in progress intended for my PhD, but that will probably never bear fruit. So knock yourself out: https://github.com/aquarians/Public/blo ... oc/vix.pdf