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

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

Figure 1 shows a snapshot of the term structure of the VIX futures over the past two months. The bubble in implied volatility in October and November has disappeared as October has expired and November has declined since it is now the front month contract. In these cases the term structure is an upward sloping one. This is typically reflective of bull markets, because longer-term volatility typically does not decline as swiftly as near-term volatility does in a rising market. As long as the term structure displays this upward-sloping shape, the bull market in stocks may remain intact.

However, if the term structure begins to flatten out or invert (meaning the futures begin to trade at a discount to the VIX Index) then a more bearish outlook may be appropriate.

Figure 1                                               Source: McMillan Analysis Corp.

Trading Strategies

A modestly bullish strategy is available with respect to the term structure, and that is to expect a widening of the difference between November and December futures. This is mildly bullish because it relies on the market rising or at least not falling much. As November expiration approaches (11/18/2009), the November futures will, by definition, see their premium erode. However, December futures may retain theirs, as long as this penchant for hedging continues. Hence, a position of long December futures, short November futures would profit if the differential between the two futures widens.

There is large leverage in this strategy because the margin required is only $625 per contract for the futures spread. Therefore, the trader needs to be aware of the leverage that this spread carries. In addition, he must be aware that this spread could invert, so losses could theoretically be large.

For those who prefer, the strategy can be implemented with options, but it loses most of its leverage characteristics in that case and also probably would not profit by as large of a dollar amount if the strategy is successful. With options, one would substitute an in-the-money November put instead of being short the November futures; he would also substitute an in-the-money December call for the long December future. So, with prices as shown in Table 1, one could consider an option spread such as: long December 24 call and long November 25 put.

NOTE: this takes advantage of the fact that VIX options now have some new striking prices: 18, 19, 24, and 26 in certain months.

VIX – Fact & Fiction

Hailed as a revolutionary benchmark when it was first introduced by CBOE in 1993, the CBOE Volatility Index^® (VIX^®) rapidly gained traction as the preeminent barometer for measuring market volatility. VIX soon was closely followed, widely quoted, and highly publicized, but never more so than in the recent past as investors looked to VIX and other indicators for insights to a global market meltdown and record levels of sustained volatility. Amidst heightened investor and media attention, it became evident that some market observers were making overly generalized interpretations of VIX, or were look­ing to VIX for information it was not designed to convey. The purpose of this Research Note is to explore five common misconceptions (see "Myths" below) that have surfaced about VIX and, in the process, to separate fact from fiction.

Myths (Acrobat).

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.