Trading VIX Futures Part II

Russell Rhoads, CFA Instructor The Options Institute

CHICAGO BOARD OPTIONS EXCHANGE

CBOE Disclaimer
Options and futures involve risks and are not suitable for all investors. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies may be obtained by contacting your broker by calling 1-888-OPTIONS, or at www.theocc.com. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all securities and futures transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. The information in this presentation, including any strategies discussed, is strictly for illustrative and educational purposes only and is not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities or futures. Supporting documentation for any claims, comparisons, recommendations, statistics, or other technical data, will be supplied upon request. Past performance is not a guarantee of future results. CBOE, Chicago Board Options Exchange, CBOE Volatility Index, VIX and The Options Institute Logo are registered trademarks and SPX is a servicemark of CBOE. S&P, and S&P 500 are registered trademarks of the McGraw-Hill Companies, Inc. and are licensed for use by CBOE. Standard & Poor's does not promote, market, sell or endorse any product based upon its indices. Copyright 2011 Chicago Board Options Exchange, Incorporated. All rights reserved.
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Outline

VIX Index / Futures Review The VIX Futures Pricing Curve

Calendar Spread

VIX vs. SPX Review

VIX as an Indicator Trade S&P or VIX Futures?

Summary / Q&A
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VIX Index
The VIX CBOE Volatility Index. Measures S&P 500 implied volatility. Based on S&P 500 Option bid/ask quotes. Uses the nearby options with at least 8 days until expiration. Has been promoted as a fear index by the business media.
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VIX Futures
VIX Futures Value is $1000 x the level of the VIX Index. Trade the next 7 months of expiration. Expire on Wednesday 30 days before corresponding S&P 500 option expiration. Have very unique characteristics relative to other financial futures.

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VIX Futures
Pricing VIX Future Dec VIX VXZ0 @ 22.65 = $22,650 Minimum price move = .05 or $50. +/- 1.00 price change = +/- $1000.

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VIX Futures
Expiration Months VIX Futures Next 8 Months Currently Dec, Jan, Feb, Mar, Apr, May, Jun, Jul

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VIX Futures
Wednesday Settlement 30 Days Before the Next Option Settlement Date
VIX Option Expiration December 2010 January 2011 February 2011 March 2011 April 2011 May 2011 Jun 2011 Dec 22 Jan 19 Feb 16 Mar 16 Apr 20 May 18 Jun 15 Next Standard Option Expiration Jan 21 Feb 18 Mar 18 Apr 15 May 20 Jun 17 Jul 15

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VIX Futures
Settlement Pricing
VIX futures are AM settled contracts. AM settlement involves a special calculation of the VIX Index taking place the morning after the end of trading for a futures contract. This is known as the Special Opening Quotation.

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VIX Futures
Special Opening Quotation (SOQ) This is a unique VIX index quote that involves only actual S&P 500 option trades. The regular VIX Index calculation uses the mid-point between bids and offers. The symbol for the SOQ is VRO.

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VIX Futures Curve

Introduction The VIX index and active futures may be plotted as a curve Due to the anticipatory nature of VIX futures the shape may vary There is a typical shape to these VIX prices

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VIX Futures Curve

VIX Index & Futures 11/16/2010
29

27

25

23

21 VIX Index Nov 09 Dec 09 Jan 10 Feb 10 Mar 10 Apr 10 May 10 Jun 10

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VIX Futures Curve

Typical Curve
27 26 25 24 23 22 21 20 VIX Index Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

Sell Short

Buy

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VIX Futures Curve

Four Months Later Normal Curve
27 26 25 24 23 22 21 20 VIX Index Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

Cover Short Sell Long

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VIX Futures Curve

Four Months Later Volatility Spike
40

36

Cover Short

32

28

24

Sell Long
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8

20 VIX Index

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VIX Calendar Spread

VIX Price Behavior Study Based on futures moving along the curve Used 46 pairs of contracts from Feb 07 Mar 07 to Nov 10 Dec 10 Studied price behavior of pairs over three month period Used the Friday prior to expiration as the roll date
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VIX Calendar Spread

Example of roll date November 17 was Nov VIX Expiration Friday November 12 was day December became front month

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VIX Calendar Spread

November 12 Nov 10 VIX / Dec 10 VIX Results Analyzed Feb 11 VIX / Mar 11 VIX Monitoring Starts

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VIX Calendar Spread

VIX Price Behavior Study Eliminated pairs where closer month was at a discount to VIX Index There were 33 of 46 pairs that remained after the first screen Analyzed price data over next three months until Friday before expiration

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VIX Calendar Spread

Example of Data Analysis January 15, 2010 Month 1 Feb 10 Month 2 Mar 10 Month 3 Apr 10 Month 4 May 10

Potential Pair

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VIX Calendar Spread

VIX Futures Curve 1/15/2010
25

23

21

19

17 VIX Index Feb 10 Mar 10 Apr 10 May 10 Jun 10 Jul 10 Aug 10

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VIX Calendar Spread

Example of Data Analysis January 15, 2010 VIX Index 17.91 VIX Apr 10 24.05 VIX May 10 24.30
Passed Screen

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VIX Calendar Spread

VIX Futures Curve 4/16/2010
25

23

21

19

17 VIX Index Apr 10 May 10 Jun 10 Jul 10 Aug 10 Sep 10 Oct 10

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VIX Calendar Spread

Example of Data Analysis April 16, 2010 VIX Index 18.36 (up 0.45) VIX Apr 10 18.20 (down 5.85) VIX May 10 19.95 (down 4.35) May VIX lost less value than Apr VIX
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VIX Calendar Spread

Example of Data Analysis March 18, 2008 Month 1 Apr 08 Month 2 May 08 Month 3 Jun 08 Month 4 Jul 08

Potential Pair

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VIX Calendar Spread

VIX Futures Curve 3/18/2008
32

30

28

26

24 VIX Index Apr 08 May 08 Jun 08 Jul 08 Aug 08

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VIX Calendar Spread

Example of Data Analysis March 18, 2008 VIX Index 31.16 VIX Jun 08 27.24 VIX Jul 08 26.96
Failed Screen

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VIX Calendar Spread

Example of Data Analysis August 15, 2008 Month 1 Sep 08 Month 2 Oct 08 Month 3 Nov 08 Month 4 Dec 08

Potential Pair

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VIX Calendar Spread

VIX Futures Curve 8/15/2008
24 23 22 21 20 19 VIX Index

Sep 08

Oct 08

Nov 08

Dec 08

Jan 09

Feb 09

Mar 09

Apr 09

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VIX Calendar Spread

Example of Data Analysis August 15, 2008 VIX Index 19.58 VIX Nov 08 22.71 VIX Dec 08 22.47
Passed Screen

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VIX Calendar Spread

VIX Futures Curve 11/14/2008
70 65 60 55 50 45 40 35 VIX Index

Nov 08

Dec 08

Jan 09

Feb 09

Mar 09

Apr 09

May 09

Jun 09

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VIX Calendar Spread

Example of Data Analysis November 14, 2008 VIX Index 66.31 (up 46.73) VIX Nov 08 62.90 (up 40.19) VIX Dec 08 53.51 (up 31.04) Nov VIX gained more than the Dec VIX
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VIX Calendar Spreads

Summary 33 pairs passed initial screen 25 of the 33 instances where the screen was passed resulted in the 3rd month being at a discount to 4th month on roll date Warning - when curve inverts result can be front month at steep premium to back months
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VIX as SPX Signal

VIX Futures are 100% anticipatory There is an inverse relationship between

the S&P 500 Index and the VIX Futures prices are based on the direction the market expects the VIX Index to settle at expiration Since futures anticipate the VIX, they also indicate the markets S&P 500 expectations
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VIX as SPX Signal

The most basic of rules Long the S&P 500 Index if Close > 200 Day Moving Average 1/1/2007 10/29/2010 results in about a 2 point S&P 500 Index gain 1/1/2007 10/29/2010 S&P 500 Index down about 234 points

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VIX as SPX Signal

Adding in a VIX Screen Long S&P 500 Index if
S&P 500 Close > 200 Day Moving Average VIX Index Close < 200 Day Moving Average
1/1/2007 10/29/2010 Result Up 185 S&P 500 Points vs. 2 Points with No VIX Screen
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VIX as SPX Signal

VIX Index vs. 4th Month VIX Future
90 75 60 45 30 15 0 1/3/07 6/22/07 12/9/07 5/27/08 11/13/08 5/2/09 10/19/09 4/7/10 9/24/10

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VIX as a SPX Signal

VIX Index vs. 4th Month VIX VIX Futures anticipate the direction of the spot index over time This results in the futures also anticipating the overall market When the VIX futures are at a discount to the index, the anticipation is for lower volatility in the future
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VIX as a SPX Signal

VIX Index vs. 4th Month VIX Checked the result of being long the S&P 500 when the index is at a premium to the future expiring four months out

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VIX as a SPX Signal

Long S&P 500 if VIX > 4th Month VIX Future Tested 1/1/2007 to 10/29/2010 Based on closing prices only Result was a gain of 252 S&P 500 points Again index was flat over same period

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VIX vs. SPX

There is an inverse relationship between

the VIX and the S&P 500 Generally when the S&P 500 is under pressure the VIX moves higher This inverse relationship creates a wide variety of trading opportunities What about trading VIX futures based on an S&P 500 opinion?
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VIX vs. SPX

VIX trading based on an S&P 500 opinion Tough to quantify (no VIX fair value) However, closer to expiration, front month trades in line with index What if you were bearish 11/15 & 11/16?

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VIX vs. SPX

S&P 500 vs. VIX 11/12 through 11/16
24 23 22 21 1180 20 19 18 Nov 12 Nov 15 1170 1160 1150 Nov 16 1220 1210 1200 1190

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VIX vs. SPX

Bearish on SPX VIX Futures 11/12 Buy Nov VIX @ 20.35 11/16 Sell Nov VIX @ 22.25 SPX Futures 11/12 Sell Dec S&P @ 1194.75 11/16 Buy Dec S&P @ 1175.00
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VIX vs. SPX

VIX futures gravitate toward the index as

settlement approaches A stock market outlook may also result in an opinion for the direction of volatility A VIX futures position in place of an S&P 500 futures position may be a viable method of trading around your opinion

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Summary / Q&A

VIX futures may be traded as a calendar

spread based on the outlook for the curve of VIX prices The VIX index and VIX futures may be used as an indicator for the overall market Also, VIX futures positions may be a viable alternative to trading market index futures

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Contact / Presentation
CBOE Volatility Index www.cboe.com/vix CBOE Futures Exchange www.cfe.cboe.com Russell Rhoads rhoads@cboe.com

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