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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.
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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.
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.
Contact Information
Please direct questions concerning this circular to Jay Caauwe at (312) 786-8855 or caauwe@cboe.com.
VIX Futures Last Trade Dates
Contract |
Last Trade Date |
|---|---|
| August 2009 | 08/18/09 |
| September 2009 | 09/15/09 |
| October 2009 | 10/20/09 |
| November 2009 | 11/17/09 |
| December 2009 | 12/16/09 |
| January 2010 | 01/19/10 |
| February 2010 | 02/16/10 |
Announcements
"VIX FUTURES AND OPTIONS: A CASE STUDY OF PORTFOLIO DIVERSIFICATION DURING THE 2008 FINANCIAL CRISIS" RELEASED
A recently released University of Massachusetts study found that certain investments in futures and options on the CBOE Volatility Index® (VIX®) could have reduced downside risk for a typical institutional investment portfolio during the 2008 financial crisis.
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.
Substantial VIX Futures Premium Continues - Why?
The CBOE Volatility Index® ("VIX"®) has been in decline since early March, reflecting the bullishness of the market over that time period. The July VIX futures contracts settled at 23.48, which is the lowest expiration settlement figure since August, 2008. This decline in VIX is comparable to the decline in the actual or historical volatility of the S&P 500® Index. Volatility dropped from a yearly high of 50% in March to 20% near July 1st and it has increased slightly, to 22% since then. So VIX and the 20-day historical volatility of the S&P 500 Index are more or less in line at this time.
However, the futures prices are another matter. Traders have kept large premiums on the futures for quite some time now, for the most part, since early June. See Table 1 for a snapshot of the current premium levels. August premiums were larger, but have shrunk some in recent days. Even so, a premium of 2.81 is relatively large for VIX futures. But that is nothing compared to the September, October, and November futures, which are all trading with premiums over 5 points. Those are literally all-time highs for premiums on these futures contracts.
As we have explained in many past newsletters, a large premium on VIX futures is generally a sell signal for the stock market. Since the premiums have ebbed and flowed over the past few weeks, yet the broad stock market as measured by the S&P 500 Index has continued to rise, one would have to say that the bearish forecast has not worked.
Source: MAC
But there can be other factors at work, factors which we want to explore in this month's letter. First, let us consider what we know is going to happen. At expiration, VIX and the expiring futures contract will converge in the a.m. settlement process. There are two ways in which that convergence can take place: 1) VIX moves up to meet the futures price, or 2) the futures prices decline to meet VIX.
In the relatively short, five year history of VIX trading, the futures have been consistently correct more often than not. Hence, VIX often moves to meet the futures. In the situation we have now futures are at a premium. This typically indicates that VIX would need to rise to meet the futures price. Generally, if VIX is rising, the stock market tends to decline. That is why we usually say that a premium on the futures is bearish for the stock market. But, in saying that, we are making the tacit assumption that VIX will move to meet the futures.
But what if it does not? What if the futures fall to meet VIX? The stock market will not necessarily decline in that case, and in fact might even rise, as has been the case recently. In a situation like that, one might conclude that option traders had put too large of a premium on the S&P 500 Index options and were wrong.
That is exactly what could be happening now. The full term structure of all the VIX contracts is shown in Figure 1 - a snapshot taken on July 24th. Several things are readily apparent. First, VIX is trading at a much lower price than the futures. Second, the August contract is lower than the others, since it is nearest to expiration and is thus being weighed down by the spot VIX to a certain extent.
Figure 1 Source: McMillan Analysis Corp.
Third, there is an upward skew in VIX futures prices in September, October, and November. Finally, the longer-term contracts flatten out around the 28 level. It is this skew in September through November that is of most interest. Remember that these futures prices are being driven by the S&P 500 Index option prices one month forward. That is, September VIX futures prices are based on October S&P 500 Index option prices; October VIX futures prices are based on November S&P 500 Index option prices, and so forth. Obviously, the S&P 500 Index option traders are seemingly reluctant to sell volatility for what they perceive could be a highly volatile market in the fall of this year. Conversely S&P 500 Index option buyers of those expiration months are seemingly willing to pay up for the options. This is what may be holding VIX futures prices up, even though VIX is low, and historical volatility of the S&P 500 Index is low. Are these option traders going to be correct? We do not know for sure, but it seems to be a consensus being placed by a lot of option traders.
A Potential Trading Strategy - Revisited
The hedge strategy that we have talked about in the past is excellent for the current scenario:
Buy VIX puts, and
Buy S&P 500 Index ("SPX") puts.
Typically, one buys 2 VIX puts for each SPX put purchased, assuming the puts have similar deltas.
Since we do not know how the convergence between VIX and VIX futures prices will occur, this strategy allows us the opportunity to potentially profit in either case. If VIX moves up to meet the futures, the stock market will likely fall and the SPX puts will likely profit and hopefully by more than the VIX puts would lose. Note that the VIX puts might not move much at all if VIX moves up, for the VIX futures might be remaining relatively unchanged.
However, if VIX futures move down to meet VIX, then the VIX puts, which are based on the futures price, will likely profit. SPX puts might remain relatively unchanged in that case.
The worst scenario would be for VIX to rise while the S&P 500 Index rises as well, but that is a highly unusual scenario over any reasonably long period of time. VIX might rise for a day or two during a volatile market rally, but over any extended S&P 500 Index rally, VIX should fall.
For more information on VIX and volatility futures including brokers, ISVs, symbols and product specifications, visit www.cboe.com/cfe |
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 © 2009 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.
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 Index (VIX) and the CBOE DJIA Volatility Index (VXD) are owned by CBOE and may be covered by one or more patents or pending patent applications.
