• Introduction
• Announcements & Calendar
• Market Summary and Analysis - featuring Larry McMillan

For VIX market information including current quotes and historical data, please visit www.cboe.com/cfe.

Welcome to Futures in Volatility!

Futures in Volatility is a monthly CFE publication focused on volatility and variance futures, featuring volatility market reports, trading strategies and feature articles from contributors such as Larry McMillan. CFE is the home of volatility futures, featuring CBOE S&P 500 Volatility Index^® (VIX^®) futures, DJIA^® Volatility Index futures, Russell Volatility Index (RVX) futures, and Three and Twelve-month S&P 500^® Variance futures. CFE makes trading volatility easier than ever.

Term Structure

The term structure of the futures contracts (i.e., the relationship between them) has flattened to the point where nearly all the futures are trading at the same price. This is a far cry from where they were last fall, when the near-term (at that time, October) contracts traded at prices 6 or 8 points higher than the second month (November, at that time) and each successive futures contract traded at a significantly higher price than its next longest-term successor. That construct described an extremely oversold market. Since then the term structure has moved lower and lower to finally reach the point we are at today. Currently, all the futures are essentially trading at the same price.

When the term structure moves in that direction, with the near-term contracts falling faster than the longer-term ones, it is generally bullish for the market. So, in a broad sense, the term structure has been flattening for nearly six months now. In theory, it may well continue to move in this direction if the current market rally continues. If that happens, eventually the near-term contract will likely be the lowest priced of the term structure, with each successive contract likely trading at a higher price than its successor. That could demonstrate an extremely overbought market, and could have a negative forecast if it should occur.

VIX Futures as a Predictive Tool (Updated)

The blended front month VIX futures are trading at a premium to VIX, and have been consistently doing so since April 3. Prior to that, there were only a few scattered days at which they traded at a premium. When these front-month futures trade at a significant premium, that is typically a precursor to a sell signal for the broad market and conversely, when they trade at a significant discount, it can act as a precursor to an eventual buy signal. We have discussed this concept in past newsletters.

The timing of the signals is not precise. Two years ago, short periods of premium or discount resulted in the appropriate move in S&P 500® Index. Recently there have been longer periods during which the aberrations between VIX and the futures persisted, eventually followed by a strong move. The most recent period of high premiums persisted from December 17, 2008 through January 28, 2009. Actually, the market had already started to decline during the latter part of that period and it is even more negative when premiums persist during a market decline. After the end of the premiums, the S&P 500 Index declined over 200 points in a month. We would anticipate that other indicators, such as equity-only put-call ratios will generate sell signals to aid in pinpointing the timing of the eventual sell. An even rarer sell signal is also setting up. Occasionally, all of the futures contracts will trade at a premium to VIX. That, of course, is typically a sell signal as well.

The red horizontal lines on the chart in Figure 1 show the two most recent periods when all the futures traded at a premium to VIX (i.e., all the colored lines are above the green line -- VIX). Those were both strong sell signals. At the far right-hand side of the chart, you can see that, all of the futures are trading at a slight premium to VIX. This may persist for a while, during which time the market can rally, as it did in April, 2008. But, if this pattern resolves itself as it has in the past, a major sell signal will likely take place in the not-too-distant future.

Figure 1                                               Source: McMillan Analysis Corp.

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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