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, 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. And, Events features upcoming CFE and Chicago Board Options Exchange (CBOE^®) conferences, seminars and webinar presentations.

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Contact Information

Please direct questions concerning this circular to Jay Caauwe at (312) 786-8855 or caauwe@cboe.com.

VIX Futures Last Trade Dates

Announcements

CBOE invites you to attend the 25th Anniversary of the Risk Management Conference^TM. The Risk Management Conference, now in its 25th year, is hosted jointly by the Chicago Board Options Exchange (CBOE), CBOE Stock Exchange (CBSX) and CBOE Futures Exchange (CFE) and has become a leading financial industry event.

CFE is listing the worlds first exchange traded mini contract on volatility.....Mini S&P 500 Vix futures, set to trade Monday March 2^nd.

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.

VIX Moves Reluctantly Higher

The February VIX^® futures expired this past Wednesday, settling at 48.40, historically an extremely high reading for VIX. But in the context of the current market, it represents another slight decline from the previous month's settlement and the fourth straight decline since the highest all-time expiration settlement of November, 2008. This is not to say that VIX is collapsing, but it has fallen back somewhat. This is not just a monthly phenomenon either; VIX just does not seem to have the spark that it did last fall.

For example, the S&P 500^® Index has broken through support at 805-810. This breakdown launched a torrent of selling in stocks that is still continuing. Yet VIX has not embraced this move, rising only modestly. In fact, for the last month or so, VIX has been caught in a range between 38 and 50. It currently is in the upper part of that range, but has not been able to stage a breakout (which would be an upside breakout) to correspond to the breakdown in S&P 500 Index.

Whatever is causing this is also present in the longer-term futures contracts as well. Recall that VIX is a 30-day implied volatility measure, so only the two nearest-term months of the S&P 500 index options are used in its computation. Longer-term S&P 500 Index options drive the price of longer-term VIX futures, of course, but not VIX itself. In short, all of the futures are trading at a discount to VIX. We saw something like this last fall, but at that time VIX was much higher and rising rapidly, so that it was probably correct at that time. By correct we mean theoretically correct; in reality, whatever price VIX, or anything else, is trading at is the correct price, determined by free market trading.

Furthermore, a series of discounts such as this is typically bullish for the stock market, but typically only after VIX peaks and begins to decline. Last fall, the discounts reached massive proportions of 14 points or more before VIX finally peaked and started to fall, at which time the discounts began to shrink and the stock market began to rally.

Source: MAC

Table 1 shows the discounts as of the close of trading on Thursday, February 19^th. As noted above, they are quite large and in fact have been larger during the trading day on most days. The only time they seemed to disappear was a couple of weeks ago, when the S&P 500 Index made a run at the top of its then trading range, at 870. So it appears that as this stock market decline persists, we may expect to see these discounts persist and perhaps even deepen.

Term Structure

The term structure describes the relationship between the various futures contracts. As you can see from Table 1, the March contract is trading at the highest price, with April next, then May, and so on. This downward sloping pattern typically emerges during a bearish phase in the market. When it stretches too far, it is usually symptomatic of an oversold condition, and then it tends to begin moving the other way in order to flatten.

Consider the chart in Figure 1. The colored lines are the various futures contracts, and the green line is VIX. The last time that all the prices converged was right around the first of this year, when the market appeared to be breaking out on the upside. That is marked on the chart as point 1 (circled). From there, the S&P 500 Index declined sharply in what turned out to be the worst January on record, culminating in a much expanded term structure. This is illustrated by point 2 on the chart. Since then, the term structure has flattened while rally attempts were made in early February, and now it appears to be expanding again, with the latest breakdown below support on the S&P 500 Index. But this current expansion is a rather mild one.

Figure 1                                               Source: McMillan Analysis Corp.

So, the action in both VIX and the term structure is rather tepid. Neither has expanded as sharply as one would expect, as the market is breaking downward and appears ready to test the November lows. The Dow Jones Industrials have already made new lows, but the S&P 500 Index has not.

What is causing this lukewarm response? It seems that the likely answer is complacency. Perhaps investors are numb to further market declines or they don't believe this is the beginning of another leg downward. In any case, when similar conditions occurred in the past, it was usually necessary for some panic to enter the market, for the volatility measures to reach extremes, before a trading bottom can be established. Perhaps it will be necessary for the S&P 500 Index to decisively break below the November lows (741) before we see the spike in VIX and the expansion of the term structure that should accompany this serious downward move in the market.

New Product

On March 2^nd, the CFE (CBOE Futures Exchange) will launch Mini VIX Futures. They will be similar to the regular VIX futures in most ways, except that they are worth $100 per point of movement, as opposed to the $1,000 per point of movement in the big VIX futures. The ticker symbol will be VM. The other pertinent details will be the same as the full size VIX futures: same expiration date, same settlement price and procedure, and same cash settlement.

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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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.

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