CBOE Futures Exchange

July 30, 2012, Volume 6, Issue 07


A CFE Newsletter focused on Volatility Futures

Volatility Newsletter

VIX Futures Last Trade Dates

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Contract Last Trade Date
August 2012 08/21/2012
September 2012 09/18/2012
October 2012 10/16/2012
November 2012 11/20/2012
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


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CBOE Risk Management Conference Europe September 5-7, 2012.

New Single-Day Volume Record Set On Monday at CBOE Futures Exchange on Monday June 18, 2012. Read more...

VIX Futures Experience Most-Active Trading Week Ever.

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

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

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 remains low

The CBOE Volatility Index (VIX) futures® contract has remained rather subdued over the past month. Shortly after June expiration, there was a short foray to highs near 21, and since then it has been lower. In general a declining VIX accompanies a rising stock market, and that has held true. The stock market, as measured by the Standard and Poors 500 Index® (SPX) has been in an uptrend.

In recent days, VIX has dropped below 17, leading to a feeling that level might be "too low." That is, traders are showing too much complacency if VIX is that low, thus it is a sign that the stock market is overbought. The last few times that VIX dropped below 17, there has been a short-lived, but rather sharp pullback shortly thereafter in SPX. That appears to be happening again.

As noted above, VIX has been in a downtrend, which is amenable to rising stock prices. For most of this year, VIX has been below 21 (between 17 and 21) and has generally been conducive to rising stock prices. VIX would likely only turn into a bearish indicator for stocks if it climbs above 21 and if it is in a sustained uptrend. (i.e., not just a spike up and back down again).

The July VIX settlement value fell to 16.76, just as the stock market was making highs for the month. This is exactly what happened in June’s VIX settlement marking a short-term high for SPX. Those June highs were eventually exceeded, but not for a couple of weeks.

Figure 1 Source: McMillan Analysis Corp

This is the second lowest settlement price in the last 16 months. Figure 1 shows the entire history of the monthly VIX settlement prices, since 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.

Premium and Term Structure

Demand for volatility protection remains strong, and is noticeable in the construct of VIX futures. VIX futures contract tend to trade with a substantial premium to VIX. Term structure of the futures continues to slope steeply upward, as it has, for the most part, since last Thanksgiving. Taken together, these features are generally bullish for stocks; although when the term structure gets “too steep,” that can be a sign of a short-term overbought condition for stocks.

Table 1 shows the state of the VIX futures term structure on July 20th. Each of the futures contracts are trading with a very large premium to VIX itself. These premiums, while large, are not as large as they were at June expiration. When taken in the context of the past eight-year trading history of VIX futures, these premium levels and steepness of the skew remain quite large. There are more traders in the current environment who are aware of the benefits of volatility protection. Their demand for these products, particularly the exchange traded notes (ETNs) and exchange traded funds (ETFs) that track volatility, have contributed to the futures premium and the steepness of the term structure. Therefore it has remained at these rather extreme levels, even though the stock market itself might not dictate such an extreme term structure.

As has been the case for the last few months, the front month VIX futures premium is starting out the new month at premium levels near or above 3.00. Those extremes continue to call for a hedged approach to the market.


Since the futures have a large premium and the term structure is steep, the same two strategies that have been suggested the last couple months continue to be viable.

One is to buy SPX puts and VIX August puts simultaneously (buying roughly 50 VIX puts for 3 SPX puts). This strategy can profit whether the stock market moves higher or lower, for it is similar to owning a straddle. It has the additional edge of being long the VIX puts, and will eventually benefit if the large August futures premium dissipates by expiration. The risk is that it takes too long for VIX futures premium to dissipate, and one loses the time value of the options he purchased in this hedge. So, the sooner it works the better.

The other strategy is a futures spread on the term structure. For example, one might buy August and sell October, when the difference between the two futures is 4.00 points or more. Once in place, that is a somewhat bearish position. That is, if the stock market falls, VIX will rise, and the term structure should flatten. The risk is that the stock market rises, while the term structure steepens even further. That risk can be hedged by taking a small long position in SPX calls in conjunction with the futures spread.

July Volatility Index Futures and Volatility Index Security Futures

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Expiring July Volatility Index Futures

July marked the first expiration of the newly launched CBOE Nasdaq-100 Volatility Index (VN) futures contract.

Like CBOE Volatility Index (VIX) futures, VN has a contract multiplier of $1,000 and is cash-settled. In contrast, volatility security index security futures including, e.g., VXEM, VXEW, GV and OV, have $100 multipliers. The current roster of volatility security index security futures reflects the implied volatility of exchange-traded funds (ETFs).

Sources: CFE, Differential Research, LLC

Final settlement values for the six expiring July contracts are determined by the opening options prices for the underlying securities. Final settlement values ranged from a high of $35.51 for the OV July future and a low of $16.76 for the July VX future.

Sources: CFE, Differential Research, LLC

While oil volatility, as represented by the July OV settlement value, finished this period the highest, the maximum daily settlement value was in the VXEW July contract at $41.55 on May 18th.

Sources: CFE, Differential Research, LLC

Conclusions drawn from an analysis of the current data are likely to change as markets continue to develop. A glance at closing settlement values suggests that volatility behavior for different asset classes is unique providing cross-volatility arbitrage opportunities.

Sources: CFE, Differential Research, LLC

Looking at the nominal spreads between the VX July future and the other July volatility index security futures, reveals significant movement. For example, the VXEW July security future premium to the VIX July future varied from $24.79 to $13.02, a difference of $11.77 for the spread. The VXEM - VX spread varied the least.

Sources: CFE, Differential Research, LLC

While the various asset volatility index futures exhibit unique characteristics, they tend to remain correlated in their capacity as risk-on/risk-off switches. However, when we look at the correlation of various unique asset volatilities we must remain aware that we are ultimately dealing with three unique types of correlations.


Underlying Correlation: The underlying asset classes demonstrate unique correlation with the other underlying assets. The SPX Index and the EEM ETF demonstrated the greatest correlation, while the NDX exhibited the least.

Sources: CFE, Differential Research, LLC, Yahoo Finance

Volatility Index Correlations: The uniqueness extends to the correlation of the various volatility indexes, such as the non-tradable estimate of current 30-day implied volatility. Despite having the greatest nominal spread difference for the associated July futures, the VIX and the VXEWZ Indexes demonstrated the greatest correlation for the period, while the OVX and the GVZ Indexes were negatively correlated.

Sources: CFE, Differential Research, LLC, Yahoo Finance

Correlations for the tradable July volatility index security index futures as below, including the newly launched VN futures contract.

Sources: CFE, Differential Research, LLC

Correlations for a longer period of volatility index security index futures, without the recently launched VN futures contract.

Sources: CFE, Differential Research, LLC

The risk of loss in trading commodity futures and options is substantial. Before trading, you should carefully consider your financial position to determine if futures trading is appropriate. When trading futures and/or options, it is possible to lose more than the full value of your account. All funds committed should be risk capital. Past performance is not necessarily indicative of future results.

Utilizing Dynamic Correlations of the VIX vs the S&P 500

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By Mark Shore, Founder of Shore Capital Management

While analyzing the utility value of the CBOE Volatility Index (VIX) futures® contract relative to the underlying market (S&P 500), a question often arises regarding the correlation of these two instruments. In this article we look at various durations of rolling correlations to determine its utility value.

The "static" correlation of two investment components is often quoted in a correlation matrix table when multiple markets are discussed or if there are only two markets, a single quote.

From January 2004 to June 2012, static correlation of daily VIX end of day data to the S&P 500 is -0.75. However, a static correlation does not always offer a strong profile of correlation. Correlation typically depends on the time duration of a holding period, thus building a profile of that period. One must keep in mind the S&P 500 has a growth component, whereas the VIX is more of a mean reverting market with moments of upward or downward spikes.

Between January 2004 and June 2012, the VIX reached its maximum close of 80.06 on October 27, 2008. It reached a minimum of 9.89 on January 24, 2007. During this period the VIX has averaged 21.08

When analyzing “dynamic” or rolling correlations, a greater depth of the profile may be determined. A common tendency of data suggests that the shorter the duration of time, the greater the probability for noise to be introduced into the results.

Chart 1: Ten Day Rolling Correlation of the VIX to the S&P 500

Data Source: www.cboe.com; Bloomberg

The static correlation of VIX to the S&P 500 is -0.75. However in Chart 1, the ten day rolling correlation points out times (moments) when the correlation ranged from -0.99 to 0.54.

Only 0.65% of the moments find the rolling correlations to be positive. Of those moments 92% of the 10 day rolling S&P 500 returns is positive.

On a short-term basis correlation of the VIX to the S&P 500 has a small probability to be positive, therefore, tending to be when the S&P 500 has positive rolling returns.

Chart 2: 20 Day Rolling Correlations of the VIX to the S&P 500

Data Source: www.cboe.com; Bloomberg

Once the duration of the rolling correlation is expanded to a 20 day rolling period; the percentage of moments of negative correlation increases from 99.35% to 100%. As stated earlier the static correlation is -0.75 over the entire period, however, 78% of the moments are less than -0.75. 5% of the moments are greater than -0.5.

Chart 3: 40 Day Rolling Correlation of VIX to the S&P 500

Data Source: www.cboe.com; Bloomberg

As the duration increases to a 40 day rolling correlation in Chart 3, the results continue to demonstrate a tendency for the correlation to be negative, but within a wide range from 0.34 to -0.95. 82% of the moments reported a correlation less than -0.75.

Chart 4: 60 Day Rolling Correlation of VIX to the S&P 500

Data Source: www.cboe.com; Bloomberg

Chart 4 illustrates a 60 day rolling basis, correlation of the VIX to the S&P 500 has remained negative and in a range of -0.44 to -0.94. 84% of those moments were less than -0.75.

In summary, the longer the duration of a rolling correlation, the higher the tendency for VIX and S&P 500 correlation to remain negative. For an investor or a portfolio manager this study offers some insight towards the added utility value of including the VX futures contract, either long or short in a portfolio, and may offer an added benefit when the S&P 500 was experiencing tail risk.

Copyright ©2012 Mark Shore. Contact the author for permission for republication at info@shorecapmgmt.com Mark Shore has more than 20 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. www.shorecapmgmt.com Mark Shore is also an Adjunct Professor at DePaul University's Kellstadt Graduate School of Business in Chicago where he teaches a managed futures / global macro course and an Adjunct at the New York Institute of Finance. Mark is a contributing writer to Reuters HedgeWorld. Mark is a frequent speaker at alternative investment events including events hosted by Goldman Sachs, Merrill Lynch, Morgan Stanley, Institutional Investor, International Association of Financial Engineers (IAFE), the University of Chicago, DePaul University, Tulane University, the Illinois Economics Association, the Illinois Institute of Technology, and HedgeWorld.

Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Always review a complete CTA disclosure document before investing in any Managed Futures program. Managed futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.

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.


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.