For more information on the CBOE Volatility Index^® ("VIX"), volatility and variance futures including brokers, ISVs, symbols and product specifications, visit www.cboe.com/cfe.

To contact the CFE, please click here.

Futures in Volatility includes several sections: Market Summary and Analysis, Trading Strategy Ideas, Volatility in Focus and Events. Market Summary and Analysis includes commentary related to VIX, VIX futures and other volatility products, as well as charts and data related to these markets. Trading Strategy Ideas features strategies focused on trading volatility products. Volatility In Focus includes feature articles and education focused on volatility related concepts. And, Events features upcoming CFE and Chicago Board Options Exchange (CBOE^®) conferences, seminars and webinar presentations.

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Press Releases

CBOE Futures Exchange (CFE) Announces Connectivity with Calyon Financial through Patsystems

VIX Futures Last Trade Dates

Market Summary and Analysis is provided by Larry McMillan. Mr. McMillan is the President of McMillan Analysis Corporation. Click Here for more information about Mr. McMillan.

Volatility levels continued to retreat for most of the last month, reflecting the positive tone set by the general stock market and thus the lessened fear among investors. However, that doesn't mean that volatility is low, just lower than it was a month ago. Overall volatility is still much, much higher than it was earlier in the year. Furthermore, from the pricing structure of the VIX futures contracts, there is no reason to expect that volatility will retreat much in the coming months. It appears that the whole volatility spectrum has shifted higher and will remain at loftier levels.

Source: MAC

The futures pricing curve has maintained this ’flat’ structure until the present time. Figure 1 shows the history of VIX futures pricing since the inception of trading in March 2004. VIX is the green line, while the various futures are the other colored lines. Pay particular attention to the far right-hand side of Figure 1. Note that the colored lines are all bunched together, just below 20.

This flat shape of the futures pricing curve is something we don't usually see. Looking again at Figure 1, note that it is very rare to find the colored lines bunched so tightly together. Only a few such times are identifiable: March 2007, July 2006, and June 2006. That's it. Those were generally transitional points, where a tightening of the futures prices occurred as VIX was dropping from an extreme high to a lower reading in line with a (new) bullish phase in the market. At none of those previous times, however, did VIX remain high (say, in the high teens or low twenties). It has always fallen back to a much lower level. But this time, that doesn't seem to be the case, as the overall futures spectrum is trading at a premium to VIX itself.

Table 2 shows the current futures pricing structure:

Source: MAC

Two very important things can be observed from the data in Table 2: 1) the futures are trading at very similar prices, so the "flat" pricing structure persists, and 2) all of the futures are trading at a substantial premium to VIX itself.

Near-Term VIX Futures Premium As A Market Predictor

In the past, we have documented the fact that the near-term (front month) VIX futures' premium tends to be a good short-term predictor of the movement in the S&P 500^® Index (SPX^SM) itself. If the futures are trading at a discount, that is bullish for the market; if they are trading at a premium, it's bearish.

The large premium in the VIX futures construct shown in Table 2 is a short-term negative for the market. This data was taken from the close of trading on Thursday, October 18th. On October 19th, the next day, the market dropped sharply. This phenomenon has been observable time and time again. In essence, if one considers that fact that the November futures closed with a 2.59 premium to VIX itself, it's tantamount to saying that the futures are predicting that VIX will rise. And usually VIX rises sharply only if the broader market (SPX) declines sharply. Hence a premium on the futures contract is a short-term bearish predictor.

We might also be able to draw some longer-term conclusions from this data. Once again, look at Figure 1. You can see that there has only been one other time where the futures were at a premium with VIX this high - at the very left side of the chart, when the futures were first listed. Premium levels were grossly inflated back then, as traders didn't yet understand the relationship between VIX and the futures. So that is not a valid comparison with today's more experienced market in terms of pricing VIX futures and options. So, it's fairly safe to assert now that things have changed. A higher-volatility environment is expected and is therefore priced into the derivatives. This does not necessarily mean that a bear market is about to begin, for we saw a strongly rising market accompanied by rising volatility back in the late 1990's.

But it does likely mean that advances won't be the boring, smooth type we saw for much of the past four years - particularly the last two. Rather, the markets will advance swiftly, get overbought, correct, and advance again. That is the pattern we saw in the 1990's and is a pattern that is much more amenable to a trader.

Figure 1 - Source: McMillan Analysis Corp.

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S&P 500 3-month Variance Futures

Variance is a measure of how spread out a distribution is. It is computed as the average squared deviation of each number from its mean. Squaring the distance from the mean has the effect of giving greater weight to values that are further from the mean. Although the variance is intended to be an overall measure of spread, it can be greatly affected by activity at the tails of a distribution. CBOE S&P 500 3-month Variance Futures are based on the realized, or historical, variance of the S&P 500 Index. CBOE S&P 500 3-month Variance Futures are quoted in terms of variance points, which are defined as realized variance multiplied by 10,000. One variance point is worth $50. For example, a variance calculation of 0.06335 would have a corresponding price quotation in variance points of 633.50, and a contract size of $31,675.00 (633.50 x $50).

Implied and Realized Components of the S&P 500 3-month Variance Futures

Because S&P 500 3-month Variance Futures are based on the realized variance of the S&P 500 Index, the price of the front-month contract can be stated as two distinct components: the realized variance and the implied forward variance. CFE will disseminate both of these values at the end of each trading day under the following tickers:

Realized Variance - RUG: An indication of the realized variance of the S&P 500 Index corresponding to the front-month Variance futures contract.

Implied Forward Variance - IUG: An indication of the future variance of the S&P 500 Index that is implied by the daily settlement price of the front-month Variance futures contract.

Variance futures contracts are forward starting three-month variance swaps. Once a futures contract reaches front-month status, it enters the three-month window during which realized variance is calculated. To calculate the variance, sum the daily returns of the S&P 500 from the swap-start date through futures expiration, then annualize the number. Because the daily returns are additive, on any day, it is possible to know both the realized variance since the first day of the swap period (RUG) and the implied variance of the S&P 500 derived from the price of the variance futures contract (IUG). For example, on March 4, 2005, the front-month Variance futures contract (VT/H5) had 10 business days remaining until settlement. Because the entire three-month swap period encompassed 62 business days, 83% of the contract's settlement value has been realized (RUG). The RUG reported by CFE that evening was 94.97 and the VT/H5 daily settlement price was 99.50. Using the following formula, we can calculate the implied forward variance (IUG) for the remaining ten days.



Where,
VT is the daily settlement price for the front-month Variance futures contract. RUG is realized variance so far in the life of the contract. T is the total number of business days in the Variance futures. t is the number of business days left until options expiration.



Taking the square root of the IUG, one finds the futures price is implying an annualized S&P 500 return standard deviation or volatility of 11.09% over the next ten days. ). For more information about the S&P 500 Three-Month Variance calculation, please visit the education page for the CFE.

Unique Features of Futures and Options on the CBOE’s Volatility Indexes

Futures and options on the CBOE’s volatility indexes have several features that distinguish them from most equity and index options. Here are links to unique features of VIX options:

• Pricing Based on Forward VIX Value
• Pricing Can Be Different for a Number of Reasons
• Wednesday Settlement
• Special Opening Quotation Price
• Negative Correlation to Stock Indexes
• High Volatility of Volatility

Links to More Information about Volatility Indexes

• VIX Options FAQ
• VIX Options Quick Reference Guide
• VIX Options Specifications
• VIX Options Video on CBOE-TV Channel 3
• VIX Options Daily Market Data
• VIX Options Delayed Option Chain
• VIX Historical Price Data
• VIX Futures Price and Volume Data
• VIX Price Charts
• VIX White Paper
• VIX Futures Primer
• VIX Bibliography

www.cboe.com/volatility

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About CBOE Futures Exchange CBOE Futures Exchange (CFE^®) is an all-electronic open access exchange, which utilizes the CBOE’s^® state-of-the-art trading system, CBOEdirect^®. CFE is the leader in providing innovative volatility risk management futures products, including VIX^® and variance futures, which enable market participants to manage volatility risk, as well as trade volatility directly. Access to CFE is available through numerous brokers, ISVs or directly via the CBOEdirect API or CBOE’s HyTS^® terminals. CFE trades are cleared by the AAA-rated Options Clearing Corporation (OCC). To contact the CFE, please click here. About Larry McMillan and McMillan Analysis Corporation Professional trader Lawrence G. McMillan is perhaps best known as the author of Options As a Strategic Investment, the best-selling work on stock and index options strategies, which has sold over 200,000 copies. An active trader of his own account, he also manages option-oriented accounts for certain individuals and in addition, he is the Portfolio Manager of The Hardel Volatility Arbitrage Fund (a hedge fund). In a research capacity, he edits and contributes to his firm’s publications: Daily Volume Alerts, The Option Strategist and The Daily Strategist—derivative products newsletters covering equity, index, and futures options. Finally, he speaks on option strategies at many seminars and colloquia in the United States, Canada, and Europe. He is quoted in publications such as The Wall Street Journal, Barron’s, Technical Analysis of Stocks and Commodities, Data Broadcasting’s Exchange magazine, Futures Magazine, theStreet.com, and Active Trader Magazine. In these capacities, he is the President of McMillan Analysis Corporation, which he founded in 1991. Prior to founding his own firm, Mr. McMillan was a proprietary trader at two major brokerage firms—primarily Thomson McKinnon Securities, where he ran the Equity Arbitrage Department for nine years.

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Copyright © 2007 CBOE Futures Exchange, LLC. All rights reserved.

CFE®, CBOE®, Chicago Board Options Exchange®, CBOE Volatility Index®, VIX® are registered trademarks of Chicago Board Options Exchange, Incorporated (CBOE). VXD and VXN are servicemarks of CBOE. All other trademarks and servicemarks are the property of their respective owners.

The information in this newsletter is provided solely for general education and information purposes and therefore should not be considered complete, precise, or current. Many of the matters discussed are subject to detailed rules, regulations, and statutory provisions that should be referred to for additional detail and are subject to changes that may not be reflected in this newsletter. The strategy discussions contained in this newsletter are designed to assist individuals in learning how volatility and variance futures as well as other volatility-based derivatives work and understanding various volatility derivatives strategies. The strategies discussed are for educational and illustrative purposes only and should be not be construed as a recommendation to buy or sell a security or futures contract or to provide investment advice. Additionally, commissions and other transaction costs have not been included in the example strategies and will impact the outcome of security and futures transactions and must be considered prior to entering into any transactions. Investors considering volatility-based derivatives should consult a professional tax advisor as to how taxes affect the outcome of contemplated transactions in volatility-based derivatives. The charts and/or graphs contained herein are intended for reference purposes only. Past performance is not indicative of future results.

The views of third party contributors to this newsletter are their own and do not necessarily represent the views of CFE or its affiliates. Third party contributors are not affiliated with CFE. This newsletter should not be construed as an endorsement or an indication by CFE of the value of any third party product or service described in this newsletter.

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606.

The methodologies of the CBOE volatility indexes are owned by CBOE and may be covered by one or more patents or pending patent applications.