• Introduction
• Announcements
• Market Summary and Analysis - featuring Larry McMillan

For more information on the CBOE Volatility Index^® ("VIX"), volatility and variance futures including brokers, ISVs, symbols and product specifications, visit www.cboe.com/cfe.

To contact the CFE, please click here.

Futures in Volatility includes several sections: Market Summary and Analysis, Trading Strategy Ideas, Volatility in Focus and Events. Market Summary and Analysis includes commentary related to VIX, VIX futures and other volatility products, as well as charts and data related to these markets. Trading Strategy Ideas features strategies focused on trading volatility products. Volatility In Focus includes feature articles and education focused on volatility related concepts. And, Events features upcoming CFE and Chicago Board Options Exchange (CBOE^®) conferences, seminars and webinar presentations.

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Reminder Circular

February and March 2008 Holiday Closures Affecting SPX, DJX, NDX, RUT and VIX Options and VX, DV, VN, and RV Futures

Last Trading Day and Expiration for March 2008 SPX, DJX, NDX and RUT Options

The last trading day for March 2008 SPX, DJX, NDX and RUT options will not be on the traditional third Thursday of the month due to a CBOE holiday on Friday March 21, 2008. As a result, the last trading day for March 2008 SPX, DJX, NDX and RUT options will be on Wednesday, March 19, 2008 and March 2008 SPX, DJX, NDX and RUT options will settle based on opening prices on Thursday, March 20, 2008.

Last Trading Day and Settlement Date for February 2008 VIX Options and VX, DV, VN and VR Futures

Because the last trading day for SPX, DJX, NDX, and RUT options will be moved up a day in March, the settlement date for VIX options and VX, DV, VN, and VR futures will also be moved up a day to Tuesday, February 19, 2008, to ensure that a thirty-day volatility measurement period occurs between that settlement date and the March 2008 expiration for the options series used to calculate the underlying volatility indexes. The last trading day for February 2008 VIX options and VX, DV, VN, and RV futures will be on Friday, February 15, 2008 because CBOE and CFE will be closed on Monday, February 18, 2008, in observance of Presidents' Day.

Please be aware that the OIC 2008 Expiration Calendar incorrectly shows the February 2008 VIX options expiration date as February 20, 2008.

Contact Information

Please direct questions concerning this circular to Darius Zakeri at (312) 786-8749 or zakeri@cboe.com.

Also:

Join us at GAIM USA 2008 in Boca Raton, FL, January 21-24, 2008. CFE will be at booth # 39 discussing volatility trading and giving demonstrations on the HYTS ® front end system.

VIX Futures Last Trade Dates

Market Summary and Analysis is provided by Larry McMillan. Mr. McMillan is the President of McMillan Analysis Corporation. Click Here for more information about Mr. McMillan.

The last month’s trading in VIX^® and its accompanying futures has arguably been the most interesting month since volatility derivatives were listed. There has been something of a discrepancy between levels of VIX and prices of the futures.  As we shall see, the futures generally had the right idea.

This saga begins in mid-December 2007, with VIX trading near 22.50.  At that time, the near-term January futures contract developed a premium of more than a point, unusually large for the front month futures.  On the surface, as we have discussed in this newsletter in the past, that is often a bearish prediction for the market.  In other words, the futures are indicating that VIX will move higher to catch up. When VIX moves higher, the broad stock market generally moves lower.  Hence a large premium in the front month futures contract is considered to be a somewhat bearish prediction for the broad stock market.

Usually a large discrepancy in premium between the front month futures and VIX is quickly dissipated as the two converge upon each other.  However, that was not the case this time.  Not only did the futures persist in remaining at a premium, but as the stock market (as measured by the S&P 500 Index^®) rallied in the few days leading up to Christmas 2007, the premium on the futures expanded dramatically.  The entire sequence of January futures premium throughout late December is shown in Table 1.

Source: MAC

The premium remained inflated from December 12^th through December 28^th.  Finally, on December 31^st, it fell back below 75 cents, about the maximum amount that can be considered expensive. Note that on December 19^th through December 28^th, the premium was over 2.00 points, with a maximum premium of 4.63 being registered on December 21^st (the largest premium for a front-month future in the history of VIX futures trading).  What was happening was that the market was rallying and stock traders were expecting a positive year-end, so they sold S&P 500 Index puts, which in turn lowered VIX.  However, the futures were not anywhere near as optimistic as they remained at inflated levels, warning that all was not right with the stock market.

Of course, we all know what happened next.  Beginning on December 27^th, the stock market as measured by S&P 500 Index sold off 21 points, a pretty big drop.  But that was only the beginning.  To date, the damage in terms of S&P 500 Index has been 186 points, a decline of 12, in just 16 trading days. A decline of that magnitude in that short of a time is rare.  Moreover, this is one of the worst starts to a year in history.  And the VIX futures predicted it all.       

Figure 1 shows all the futures, and VIX (green line).  Note how clearly VIX is below all of the futures on the right-hand side of the chart – i.e., during the time frame shown in Table 1. 

Figure 1 Source: McMillan Analysis Corp.

As S&P 500 Index declined sharply, something else occurred that was unusual: VIX did not rally sharply.  It has almost always been the case that volatility measures shoot higher when the market suffers a steep decline, such as the current one.  Eventually VIX spikes to a peak and collapses, and that is a major buy signal for the stock market.  In Figure 1, note the VIX spikes in August and November, both well-timed harbingers of strong S&P 500 Index rallies that followed.

But, here in 2008, VIX was only meandering higher, rather than dramatically spiking upward.  There is a great deal of debate as to why this is the case.  Some claim it is because traders already had S&P 500 Index puts in position as hedges, and when the market fell, they unwound those hedges to take profits on them.  In doing so, they were put sellers of course, and that supposedly held VIX down.  It is not clear whether that was really the driving force behind the low VIX or whether it was something simpler, such as the fact that traders were overly complacent and did not see the need to panic to buy S&P 500 Index puts (and thereby inflate VIX).  In either case, the fact that VIX would not spike seemed to prolong the pain in the stock market as it continued to fall, day after day.

Finally, on Thursday, January 17^th, a day after the Jan VIX futures expired, VIX finally shot 4.08 points higher in one day. That is the type of capitulation and panic put buying that often leads to a market bottom, or at least a strong, tradable rally.  Moreover, and perhaps most importantly, the February VIX futures (now the front month) – dropped to a discount at Thursday’s close.  This discount was sizeable, too – 1.49 points.  Table 2 shows the current VIX futures, all now at discounts to VIX itself.

So, perhaps at least a temporary bottom for stocks is not too far off.  It may not happen immediately.  Just as the large premium in January VIX futures persisted for a few days before selling started, it may be the case that a discount exists for a few days before a rally begins.  But it is certainly the first encouraging, bullish sign that VIX and its futures contracts have given in the last month.

Strategy

A calendar-spread strategy is potentially setting up again.  As the market has collapsed, the near-term futures have gotten quite a bit more expensive than longer-term futures.  Hence a calendar spread in which one buys intermediate-term futures and sells near-term futures has a reasonable chance of profit, especially if the stock market stabilizes or rallies.

From the data in table 2, you can see that if the May futures were bought (at 26.36) and the February futures were sold (at 26.97), that is a differential of 0.61, February over May (or a credit of 61 cents, it you are an option trader).  While that is not a big differential, it is likely to shrink if S&P 500 Index stabilizes or rallies (and VIX simultaneously declines). 

Source: MAC

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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:

• Pricing Based on Forward VIX Value
• Pricing Can Be Different for a Number of Reasons
• Wednesday Settlement
• Special Opening Quotation Price
• Negative Correlation to Stock Indexes
• High Volatility of Volatility

Links to More Information about Volatility Indexes

• VIX Options FAQ
• VIX Options Quick Reference Guide
• VIX Options Specifications
• VIX Options Video on CBOE-TV Channel 3
• VIX Options Daily Market Data
• VIX Options Delayed Option Chain
• VIX Historical Price Data
• VIX Futures Price and Volume Data
• VIX Price Charts
• VIX White Paper
• VIX Futures Primer
• VIX Bibliography

www.cboe.com/volatility

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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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*     This is a paid advertisement. The inclusion of these advertisements should not be construed as an endorsement of any product, service, or Web site or as an indication of the value of any claims, recommendations or other information contained therein.

Copyright © 2007 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 (CBOE). VXD and VXN are servicemarks of CBOE. All other trademarks and servicemarks are the property of their respective owners.

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 indexes are owned by CBOE and may be covered by one or more patents or pending patent applications.