CBOE Futures Exchange
November 29, 2012 Volume 6 Issue 11


A CFE Newsletter focused on Volatility Futures

VIX Futures Last Trade Dates

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Contract Last Trade Date
December 2012 12/18/2012
January 2013 01/15/2013
February 2013 02/12/2013
March 2013 03/19/2013
April 2013 04/16/2013
May 2013 05/21/2013
June 2013 06/18/2013
July 2013 07/16/2013
August 2013 08/20/2013


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Brodsky At CBOE Risk Management European Conference: Announces Plans For 24-Hour VIX Futures Trading And CFE London Hub

CBOE Futures Exchange And DRW Trading Group Complete Agreement To Create Stock Index Variance Futures.  

CFE Data Center Move to Equinix NY4 Data Center
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Market Summary & Analysis

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Market Summary and Analysis is provided by Larry McMillan. Mr. McMillan is the President of McMillan Analysis Corporation.

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Volatility diverges from stock price movement

An interesting movement in the CBOE Volatility Index® (VIX®) took place this month. The S&P 500 Index (S&P 500) declined, as well as the stock market in general, yet VIX has not risen. The VIX futures settlement value was 15.05 for November which expired on the 21st, down from 15.96 in October. A look at the chart of VIX (Figure 1 below) shows a more complete picture than that depicted by the settlement values, which are just isolated once-per-month data points. VIX futures rose to roughly 19 in late October, but since then it generally has been trending lower. The action in November is what is particularly noteworthy: the S&P 500 declined from 1430 to 1350, but VIX also declined – moving from 19 to 16 while the stock market fell.

This type of action is a divergence from "normal" movements. Typically, VIX will rise when the S&P 500 falls, and vice versa. This is not the first time that such a divergence has taken place. On a daily basis, it occurs relatively often, but daily movements are generally small and not too meaningful. It is rare for the divergence to persist over a period of time. Perhaps the most significant time a similar divergence occurred was in February-March 2009. That was when the stock market was making its final plunge after the financial crisis of 2008. The S&P 500 fell from 870 to 670 in a month, and VIX was slightly down (from 44 to 42).

Figure 1 Source: McMillan Analysis Corp

It is not always clear what causes divergences such as these, but one major factor seems to be the demand for protection. In a declining market, usually both retail and institutional traders want to buy protection, and pay up for S&P 500 puts, which drives the price of VIX futures higher, or they buy VIX futures directly. This is what happened in September-October 2008 to great extremes. Also, it happened to a lesser extent in May 2010 (the "flash crash") and August 2011.

However, if traders already have protection, there might not be demand for more when the market declines. In fact, just the opposite may occur; traders who already own protection want to sell it as the market declines. If there is no countering demand for protection it is possible that the sellers may hold down the implied volatility of S&P 500 puts. VIX would decline even in a market where the S&P 500 is declining. That seemed to be the case in 2009, where everyone who wanted to buy protection had already done so and VIX did not decline even as the S&P500 fell by 200 points in early 2009.

This seems to be what is happening again now. We have pointed out for months that there was a large "protection trade" being established. Traders were buying stocks in the S&P 500 and also buying protection very heavily. They even paid handsome prices for that protection at times. Now, it seems that they want to sell off some of that protection since the stock market (S&P 500) has declined. But to whom can they sell it? Apparently the demand for near-term protection has now waned, and so these sellers of protection are once again holding down the implied volatility of S&P 500 puts and that, in turn, typically holds down the price of VIX.

As noted earlier, the VIX settlement value fell to 15.05 in November. That is a very low level, when compared against the entire history of VIX settlements (See Figure 2). Except for September 2012, it is the lowest level since June 2007. Figure 2 shows the entire history of the monthly VIX settlement prices, since the inception of futures trading in May 2004 (trading first began in March, 2004, and the first contracts that settled were the May, 2004, futures). The symbol for the monthly settlement price is VRO. The S&P 500 Index (SPX) is also overlaid on the graph. While there is not a perfect (inverse) correlation between SPX and VRO (and, by inference, VIX), one can see the general tendency of the two to move in opposite directions.

Figure 2 Source: McMillan Analysis Corp

Premium and Term Structure

The current state of the VIX futures term structure is shown in Table 1. There are some interesting developments that have occurred. Before addressing them, though, it is important to remember that VIX itself is a weighted blend of only the first two months of S&P 500 options (SPX options). The 3rd and later months are not part of the VIX calculation. The reason that I point this out is that there is a difference in behavior of near-term VIX futures and longer-term ones.

The futures premium in the first two months is quite low in comparison to the others. This reflects the low VIX that we talked about earlier. The fact that the remaining futures are trading at substantially higher prices than its immediate predecessor, means that the term structure continues to slope steeply upward.

In conclusion there is still demand for protection in the later months. So the selling off of protection is taking place only in the near-term SPX options (which directly reflect VIX and near-term VIX futures). However, the longer-term ones continue to trade with large premiums to VIX itself. Thus, the "protection trade" is still alive in these longer-term futures.

In a bearish market, and one would have to say that S&P 500 declining from 1470 to 1340 in just over a month is a relatively bearish market, the term structure normally flattens. If the bearish market develops into something seriously bearish, the term structure actually inverts. The fact that the current term structure continues to slope so steeply upward, despite a decline of 130 points in S&P 500 is evidence that the "protection trade" is still very much in force in the 3rd and later months of the SPX options and VIX futures.


With VIX near 15, one would typically think of employing strategies that involve buying VIX futures or call options and/or buying SPX puts. Those would be speculative strategies, of course, not hedged strategies. The problem is that VIX has been diverging from stock market movements of late, and so we cannot be certain that what "normally" holds true will prove to be profitable in the near future.

But at this point in time, I think that a speculative strategy is more attractive than a hedged strategy, specifically because of the current divergence between the S&P 500 and VIX.

From a speculative point of view, VIX could rise even if the stock market rises. In fact, it does not appear that traders are willing to let VIX go much lower (it did not fall much on Friday, November 23rd, when the S&P 500 rose by a strong 18 points). So, a purchase of VIX futures or VIX calls expiring no later than January is likely the best speculative play at this time.

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Volatility Index and Volatility Index Security Futures

The article below is provided by Michael McCarty. Mr. McCarty is the founding member and chief strategist of Differential Research.

CBOE Futures Exchange, LLC (CFE) lists futures and security futures on six different volatility indexes that provide up-to-the-minute market estimates of the expected volatility of several different asset classes. These six unique products are calculated by applying the CBOE Volatility Index (VIX) methodology to CBOE-listed options on a diverse group of stock indexes and Exchange-Traded Funds (ETFs). This column for the last few months has focused discussion on potential arbitrage opportunities among these products and the possibility to capitalize on changing relative volatility expectations between asset classes.

So far we have focused on the relative value and the relationships between the volatility indexes as well as the daily settlement values for common expiration futures. With November expiration now past and several months of multiple futures' expirations now available, we can begin to look at the relative relationships at final settlement. While the data set is limited, it describes the historical ranges from which new extremes may be reached.

First let us look at the recent November expiration:

Sources: CFE, Differential Research, LLC

This month, the November CBOE Gold ETF Volatility index security future (GV), which represents the implied volatility for gold derived from the option prices for the SPDR Gold Shares GLD ETF (GLD), had the lowest settlement value of $12.96. The November CBOE Crude Oil ETF Volatility index security future (OV), which represents the implied volatility for oil derived from option prices on the United States Oil Fund, LP ETF (USO), had the highest final settlement value of $30.02.

Sources: CFE, Differential Research, LLC

With the volatility index and volatility index security futures' forward curves in contango for the life of the November futures, contract highs were set near their introduction while lows were set at or near expiration.

Sources: CFE, Differential Research, LLC

Notably, the November CBOE Emerging Markets Volatility index security future (VXEW), which represents the implied volatility of the MSCI Emerging Markets Index derived from option prices on the iShares MSCI Emerging Market Index ETF (EEM), fell sharply at expiration.

Sources: CFE, Differential Research, LLC

The chart below shows the relationships of the November volatility index and volatility index security futures daily settlement prices compared to the November CBOE Volatility Index (VIX) future:

Sources: CFE, Differential Research, LLC

The daily settlement values for the November CBOE NASDAQ-100 Volatility Index future (VN), which represents the implied volatility of the NASDAQ-100 Index (NDX) derived from option prices on the NDX, differed the least from the November VIX daily settlement value.

Sources: CFE, Differential Research, LLC

Turning from the November futures and the November expiration, let's look at the history of expirations and final settlement values since the expiration of the first GV security future in May of 2011.

Sources: CFE, Differential Research, LLC

While a small data set may fail to yield high-confidence conclusions, it is simple to review.

Sources: CFE, Differential Research, LLC

Sources: CFE, Differential Research, LLC

Notably the November 2012 expiration, which just passed, yielded several of the minimum expiration spreads.

Sources: CFE, Differential Research, LLC

The GV security future was the only security future to settle at a discount to the concurrent VIX future, while settling at both a premium and a discount.

Sources: CFE, Differential Research, LLC

As trading volume for volatility index and volatility index security futures outside of the popular VIX futures continues to grow, different assets' implied volatilities will increasingly present arbitrage opportunities.

An important factor for anyone considering establishing an arbitrage position in volatility futures is contract size. For VIX and VXN futures the contract multiplier is $1,000 while the contract multiplier for volatility index security futures is $100.

Trading the True Range of the VIX Futures

By Mark Shore, Founder of Shore Capital Management.

Continuing the series of discussing various methods of trading the CBOE Volatility Index® (VIX®) futures contract at CBOE Futures Exchange, LLC (CFE), we will discuss the utility of the True Range indicator and the Average True Range indicator. In previous articles we discussed the use of spreading, correlations, moving averages and the Aroon indicator as methods of trading VIX futures.

Liquidity is an important factor of risk management. CFE announced on November 1, 2012, record volume in October 2012 for both the VIX futures contract and total volume of the Exchange. VIX futures reached a record 2,443,878 contracts traded in October 2012, a 172% increase from October 2011 and a 2% increase from September 2012. The October 2012 Average Daily Volume was 116,375 contracts, a 172% increase from October 2011 and a decrease of 8% from September 2012. However, the markets were closed for two days in October due to hurricane Sandy.i

In previous articles we discussed VIX futures as a mean-reverting market tending to find major price support between 10 and 15 and major price resistance around 40. However, within this range, market turning points do develop from time to time. The True Range indicator is a method of seeking changes in market momentum.

The True Range indicator and the Average True Range were developed by Welles Wilder, also known for developing the Relative Strength index, Directional Movement and the Parabolic Stop and Reverse. True Range is considered a metric of a market's activity or volatility. Wilder first published the True Range indicator in his 1978 book "New Concepts in Technical Trading Systems". The True Range indicator posits that the higher the number, the more likely the market will change direction. A lower number would indicate a weaker trend or indication of a sideways market. The True Range is defined as the maximum value of the following: 1) today's high to today's low; 2) yesterday's close to today's high; and 3) yesterday's close to today's low. The Average True Range is a moving average of the True Range.

VIX futures are an indicator of S&P 500 Index volatility and True Range is a volatility of the volatility or a second derivative of the volatility.

Chart 1: Monthly Nearest VIX Futures Chart with a 7 Month Average True Range

Sources: www.barchart.com

In Chart 1 of the nearest monthly VIX futures contract, True Range peaks in conjunction with the VIX futures as found in the circled areas. This is a monthly chart and the peaks are major turning points in the market. Peaks are at or near a price of 40 with the exception of the financial crisis in 2008 and the lower volatility in 2012.

You will notice the True Range value in each chart becomes smaller as the charts move from monthly data to daily data. This is due to the fact that the differentials to calculate the True Range are larger in monthly data than in daily data.

Chart 2: Weekly Nearest VIX Futures Chart with a 7 Week Average True Range

Sources: www.barchart.com

Chart 2 of the weekly nearest VIX futures contract once again shows moments of when the VIX futures and the True Range were peaking as indications of VIX futures becoming overbought and possibly changing direction. Between October 6 and October 8, 2008, the True Range reached 27.76 and the VIX futures reached 69.40. Soon after the True Range fell the Average True Range began falling. On May 3, 2010 the True Range peaked at 20.35 and moved lower in the following weeks as did the VIX futures.

As you will notice, the True Range tends to move faster than the VIX futures contract does, indicating a reversal. The time period of August to November of 2011 is a good example of when the True Range was falling while the VIX futures continued trending. As the Average True Range lags the True Range tend to correspond more precisely to the turning points of VIX futures. However, there could be some logic in utilizing the combination of the True Range when the market is nearing a correction as a place to exit or lighten a position; the Average True Range could be used for an entry trigger point.

Chart 3: Daily Nearest VIX Futures Chart with a 7 Day Average True Range

Sources: www.barchart.com

The circled areas of Chart 3 show the daily nearest VIX futures contract. It points out moments when the True Range and VIX futures peaked. For example on February 14, 2012, the True Range peaked at 4.8 as the VIX futures peaked on February 16, 2012 at 24.95. On March 20, 2012 the True Range peaked at 5.3 and the VIX futures peaked at 20.85.

Chart 4: Daily December 2012 VIX Futures Contract with 7 Day Average True Range. Ending Nov 20, 2012

Sources: www.barchart.com

Chart 4 of the daily December 2012 VIX futures finds moments of the True Range falling as the VIX futures price peaks. June 8, 15 and 21, 2012 are dates of the True Range peaking and the VIX futures consolidating as it prepares to fall. Another turning point was July 23 and July 26, 2012. September 6 and September 13, 2012 demonstrates the VIX futures price decaying as the True Range is peaking.

The signals of the indicator tends to be more defined in the monthly and weekly data then in the daily data, however it does offer more short term signals in the daily data. The daily True Range may offer more efficiency when combined with weekly and monthly data or with other indicators. The Average True Range is frequently used as a component in trading strategies and may offer ideas for the investor or the Commodity Trading Advisor to include VIX futures into their portfolio.

This article is not intended to recommend a specific trading strategy, but to educate the reader on various strategy ideas to investigate beyond spreads or hedging of volatility futures.

If you have a favorite volatility futures trading strategy you would like to share, please email: info@shorecapmgmt.com

i Total VIX Futures Volume Reaches New All-Time High in October, November 1, 2012, www.cboe.com http://ir.cboe.com/releasedetail.cfm?ReleaseID=718129


Please direct questions concerning this circular to:

Jay Caauwe

Jennifer Fortino

About Larry McMillan and McMillan Analysis Corporation
Lawrence McMillan is the recipient of the Sullivan Award for 2011, awarded by the Options Industry Council in recognition of his contributions to the Options Industry. 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.

About Michael McCarty
Michael McCarty is the founding member and chief strategist of Differential Research. An independent provider of derivative research for institutional investors. Differential Research was founded to capitalize on the growing importance of risk and volatility analysis in the investment process. Mr. McCarty is a frequent guest on BloombergTV, Fox Business News and CNBC, in addition to being quoted regularly by the financial press. Mr. McCarty also speaks frequently on the topics of risk and volatility at investment industry conferences.

Michael McCarty was formerly the Chief Strategist at Meridian Equity Partners, an independent broker dealer. As director of the firm's Option Market Operations, Mr. McCarty published two widely-read notes per day, targeting on the US marketplace and uncovering Noteworthy Option Activity.

Born in the Republic of Panama and raised in Central Florida, Mr. McCarty's fascination with the financial markets came early on, first studying finance and history at Emory University, then obtaining a Masters Degree in Finance from New York City's Baruch College – Zicklin School of Business. His vast knowledge and deep understanding of the equity and derivative markets, the result of a twenty-five year Wall Street career as sales-trader, analyst and market strategist has allowed him to accumulate a significant following of the most respected and accomplished investors worldwide.

About Mark Shore
Mark Shore has more than 20 years of investment, research and futures experience. In 2008 he founded Shore Capital Management LLC where he consults in alternative investments regarding due diligence, research, educational workshops and business development. He is a frequent speaker at alternative investment events. He has published several papers on alternative investments and asset allocation. His research is found at www.shorecapmgmt.com.

Mr. Shore is an Adjunct Professor at DePaul University's Kellstadt Graduate School of Business where he teaches a graduate level managed futures/ global macro course. He is also an Adjunct Instructor at the New York Institute of Finance and a Contributing Writer for Reuters HedgeWorld and the CBOE Futures Exchange. Prior to founding Shore Capital, Mr. Shore was Head of Risk for Octane Research Inc ($1.1 billion AUM) in NYC from 2007 to 2008, where he was responsible for quantitative risk management analysis and due diligence of Fund of Funds. He chaired the Risk Management Committee and was a voting member of the Investment Committee.

Prior to joining Octane, he was at VK Capital Inc from 1997 to 2006, a wholly owned Commodity Trading Advisor ($250 million AUM) of Morgan Stanley. As Chief Operating Officer of VK Capital, Mr. Shore provided research and risk management expertise on portfolio issues, product development and business strategy. Mr. Shore graduated from DePaul University with a degree in Finance. He received his MBA from the University of Chicago.

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.

Copyright 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.