CBOE Futures Exchange

February 28, 2012, Volume 6, Issue 02


A CFE Newsletter focused on Volatility Futures

Volatility Newsletter

VIX Futures Last Trade Dates

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Contract Last Trade Date
March 2012 03/21/2012
April 2012 04/18/2012
May 2012 05/16/2012
June 2012 06/21/2012
July 2012 07/18/2012
August 2012 08/22/2012
September 2012 09/18/2012
October 2012 10/16/2012
November 2012 11/20/2012


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Look for us at the 28th Annual Risk Management Conference March 11-13th in Bonita Springs, FL  Read more...

We'll also be at the 37th International Futures Industry Conference in Boca Raton, FL, March 13-16, 2012  Read more...

On February 2, 2012, CBOE Futures Exchange, LLC (CFE) listed Radar Logic 28-Day Real Estate Index (RPX) Futures.  Read more...

CBOE Futures Exchange Puts Real Estate on the Radar  Read more...

On February 21, 2012, CBOE Futures Exchange, LLC (CFE) listed security futures on the CBOE Brazil ETF Volatility Index ("VXEWZ"). Read more...

View our first two webinars with OptionsCity:

Record Vix Volume How and why trade Vix options and futures

Trading Vix futures and futures spreads

A CBOE Community Blog
Whats on Our Minds: Read the CBOE Blogs

Product Specifications Overview Weekly Options on VIX Futures

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Contract Size One (1) VIX futures contract
Trading Hours 8:30 a.m. - 3:15 p.m., Chicago time
Ticker Symbols VOW1 - Week 1
VOW2 - Week 2
VOW3 - Week 3
VOW4 - Week 4
VOW5 - Week 5 (if needed)
Strike Price Intervals May be no less than $0.50
Minimum Price Intervals 0.05 points
Dollar Value Per Tick $50.00 per contract
Exercise Style American - any day up to and including the expiration date
Expiration Date/Last Day to Trade Week 1 -- 1st Friday of contract month
Week 2 -- 2nd Friday of contract month
Week 3 -- 3rd Friday of contract month
Week 4 -- 4th Friday of contract month
Week 5 --5th Friday of contract month
(if needed)
Delivery Exercise of Weekly VIX Futures Options results in delivery of VIX futures with an expiration date closest to, but after the expiration date of the options contract.

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.

VIX stabilizes; futures premium is large
The CBOE Volatility Index (VIX) has ceased its long declining trend that began last October. It bottomed out in the 17 area and has recently probed as high as 22. However, this does not appear to have caused problems for the stock market, measured by the S&P 500 Index (SPX). If VIX settles into a trading range between 17 and 22, stocks may still move higher. Only a rising trend in VIX may be problematic for stocks.

Meanwhile, the VIX settlement value this month was 20.44, a decline of over 3 points from last month. This was the lowest monthly settlement since last July, just before the market broke down. Figure 1 shows the entire history of the monthly VIX settlement price, 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 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 1 Source: McMillan Analysis Corp

Figure 2 shows the current chart of VIX. You can see that the long downtrend line has been penetrated, and the 20 day moving average is flattening out. VIX probed as low as 17 three times (twice in late January and once in early February) which could be regarded as being at the low end of the “new” trading range. In a similar fashion, VIX probed upward to 22 on three different occasions this month. Most of those were associated with negative rumors emanating from Europe. As shown on the chart in Figure 2, this could be the VIX trading range for a while. A breakout to the upside would likely be bearish for stocks, although stocks may continue to advance while VIX is trading in a sideways range.

Figure 2 Source: McMillan Analysis Corp

Premium and Term Structure
Table 1 shows the state of the VIX futures term structure on February 17th. Two things stand out: 1) the futures are all trading in very large premiums to VIX, and 2) the term structure of the futures slopes steeply upward through at least August. We mentioned last month how steep the term structure was, however, it is even steeper now. It is rare to see any of the futures trading at a 10-point premium or more to VIX, but there are four of them at this time.

This term structure is likely the result of the ongoing and rather powerful bull market that has been underway since last October. This does not necessarily mean that futures traders are especially leery of what might happen next summer. Nor does it means that traders “expect” VIX to rise to 28 or 29 by that time. Rather, it is likely attributable to what implied volatility traders are willing to pay for protection in those months. There is heavy demand for protection of stock portfolios whether that protection is to own SPX puts or to own VIX futures.

In the early days of VIX derivatives trading, the majority of users were mostly all “smart money” traders. When the futures developed a large premium that created a warning sign for stocks. But in the wake of the 2008 financial crises, things changed. Average traders, not “smart money” traders, learned the value of owning protection. However, they do not seem to have any particular prescience for timing or for how much to pay. As a result, during long bull runs, the term structure tends to steepen greatly and the futures are likely gaining premium because more and more “average investors” are buying protection. All we can really say is that they appear to be paying too much for this protection, especially in the later months.

The best strategy to use when the term structure is this elevated and when the futures have such large premiums is this:

Buy VIX March puts
And Buy SPY March puts

Alternatively, if one prefers, he could instead:

Alternative position:
Sell March VIX futures
And Sell March S&P futures

The option version has limited, defined risk, but does entail an expense for time value premium. The futures version has last unlimited (or large) risk, but is not time value expensive.

In either case, there is an “edge” due to the large premium on the VIX futures. If the markets just stay where they are, these trades would make money as the March VIX futures eventually would lose their premium to VIX as March expiration approaches.

Due to the different prices of VIX and SPX and the differences in their volatilities, one would not trade one VIX contract while offsetting it with one S&P or SPY contract, but rather trade more VIX than SPY. For example, 5 VIX puts vs. 3 SPY puts.

If the term structure flattens and the March premium disappears quickly, the trade should show a profit and should be exited then. However, if the term structure lingers in its current form, then one might have to hold the premium until expiration is at hand.

VIX Futures in Focus

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VIX Futures in Focus is provided by Michael McCarty. Mr. McCarty is the founding member and chief strategist of Differential Research.

The February VIX Index future

Sources: CFE, Differential Research, LLC

This month's expiration of the February 2012 CBOE Volatility Index (VIX) future marked the 90th expiration for VIX Index futures contracts. The first daily settlement value for the February 2012 VIX future was 24.95 on June 20, 2011 and the contract traded between a low of 17.90 on February 3, 2012 and a high of 36.85 on October 4, 2011, finally settling at a value of 20.44 on February 15, 2012. During its lifetime, the February 2012 VIX future had a volume high of 34,437 contracts, peak open-interest of 71,478 contracts and expired with 22,153 contracts outstanding.

Sources: CFE, Differential Research, LLC

New Volatility Products Update:
The, CBOE Futures Exchange, LLC (CFE) last year announced plans to launch security futures on volatility indexes calculated using options on a group of exchange-traded funds (ETFs) representing a diverse group of asset classes.

CBOE Extends Its Volatility Franchise: Applies VIX Methodology to Options on Six Actively Traded ETFs

Two new volatility index products, the CBOE Brazil ETF Volatility Index (VXEWZ) security futures (VXEW) and the CBOE Crude Oil ETF Volatility Index (OVX) security futures (OV), joined the recently launched CBOE Emerging Markets ETF Volatility Index (VXEEM) futures (VXEM) and the previously listed CBOE Gold ETF Volatility Index (GVX) security futures (GV), with more products to come. It is worthwhile to look at these offerings in more detail and examine some recently announced changes that are likely to increase the probability of success for these and other volatility products.

Multiplier Change
Beginning on February 21, 2012, the contract multiplier for all Volatility Index security futures was changed to $100 per contract. See CFE Regulatory Circular RG12-12 (There was no change to the contract multiplier for VIX futures and it remains $1,000 per contract). The reduced contract size will aid investors seeking to maintain exposure to volatility in a portfolio and will likely increase the investor base to include smaller institutional and retail investors. The reduced contract size will also increase the attractiveness of inter-asset class arbitrage opportunities (for example: buying VXEW futures and selling VXEM futures).

As the new multiplier will be equivalent to the multiplier for options on the same volatility indexes, hedging futures positions with security options will be more intuitive, potentially increasing the products' audience.

CBOE Gold ETF Volatility Index and Security Futures
The CBOE Gold ETF Volatility Index (GVZ) is calculated using CBOE listed options on the SPDR Gold Shares ETF (GLD). The GLD ETF holds physical gold. On March 25, 2011, CFE listed security futures on GVZ, which promised to be an interesting product. With gold typically possessing a positive skew, a likely result of its risk to the upside representing the world's "anti-currency," gold and GLD volatility has historically differed considerably from equity volatility as shown by GVZ. Since the launch of the GVZ product in March 2011, the SPX Index and the GLD ETF have become more negatively correlated to the US Dollar Index (DXY).

Sources: CFE, Differential Research, LLC

CBOE Emerging Markets ETF Volatility Index and Security Futures
The CBOE Gold ETF Volatility Index (GVZ) is calculated using CBOE listed options on the SPDRThe recent launch of the CBOE Emerging Markets ETF Volatility Index security futures contract (VXEM) has been successful. As we described in last month’s "Futures in Volatility," the VXEEM Index and consequently the VXEM security futures are highly correlated with the VIX Index and the VIX futures contract, both representing equities that tend to create natural spread and arbitrage opportunities.

Sources: CFE, Differential Research, LLC

The first expiration for the VXEM security futures contract occurred in February 2012. Following its January 9, 2012 launch, the future achieved peak volume of 172 contracts, peak open interest of 127 contracts and expired with 19 contracts outstanding.

Sources: CFE, Differential Research, LLC

CBOE Brazil ETF Volatility Index
CBOE Brazil ETF Volatility Index security futures (VXEW) began trading on February 21, 2012. This product offers investors a third equity volatility index instrument creating the potential for multiple inter-asset volatility trades.

With greater "vol of vol" VXEW security futures are also likely to appeal to speculators looking to capitalize on a directional view of volatility.

CBOE Crude Oil ETF Volatility Index

With security futures and options slated for recent launches on CFE and CBOE, respectively, CBOE Crude Oil ETF Volatility Index products should appeal in particular to traders seeking volatile volatility products.

VIX White Paper

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The CBOE Volatility Index (VIX ) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility.

VIX White Paper (Acrobat).

CBOE Volatility Indexes

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CBOE's volatility indexes are key measures of market expectations of near-term volatility conveyed by stock index option prices. The indexes measure the market's expectation of 30-day volatility implicit in the prices of near-term index options. The indexes are quoted in percentage points, just like the standard deviation of a rate of return, e.g. 19.36. CBOE disseminates the index values continuously during trading hours. The indexes are leading barometers of investor sentiment and market volatility relating to key stock indexes.

Unique Features of Futures and Options on the CBOE's Volatility Indexes

Futures and options on the CBOE's volatility indexes have several features that distinguish them from most equity and index options. Here are links to unique features of VIX options?


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.

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.