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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.
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Welcome to Futures in Volatility!
Futures in Volatility is a monthly CFE publication focused on volatility and variance futures, featuring volatility market reports, trading strategies and feature articles from contributors such as Larry McMillan. CFE is the home of volatility futures, featuring CBOE S&P 500 Volatility Index® (VIX®) futures, DJIA® Volatility Index futures, Russell Volatility Index (RVX) futures, and Three and Twelve-month S&P 500® Variance futures. CFE makes trading volatility easier than ever.
Futures in Volatility includes several sections: Market Summary and Analysis, Trading Strategy Ideas, 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. And, Events features upcoming CFE and Chicago Board Options Exchange (CBOE®) conferences, seminars and webinar presentations.
Contact Information
Please direct questions concerning this circular to Jay Caauwe at (312) 786-8855 or caauwe@cboe.com.
VIX Futures Last Trade Dates
Contract |
Last Trade Date |
|---|---|
| June 2009 | 06/16/09 |
| July 2009 | 07/21/09 |
| August 2009 | 08/18/09 |
| September 2009 | 09/15/09 |
| October 2009 | 10/20/09 |
| November 2009 | 11/17/09 |
| December 2009 | 12/16/09 |
Announcements
Jay and Michael will be attending GAIM International, June 16-18 in Monte Carlo, where Jay will be moderating a panel on "Success Strategies For Trading The VIX: Understanding The Structural Factors In The Volatility Market"
CFE will be launching event binary contracts, pending final regulatory approval. The CFE Purchase-Only House Price Index (HPI) Binary Option contract and the CFE U.S. Consumer Price Index for All Urban Consumers (CPI-U) Binary Option contract will be the first two contracts introduced. Watch this space for more details or contact the CFE helpdesk.
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.
VIX® Continues To Trend Lower
CBOE Volatility Index® ("VIX"®) futures settled at 27.04, the lowest settlement price since last August. However, lest one immediately jump to the conclusion that VIX is cheap, note that May's settlement price is higher than all monthly settlements from the inception of VIX futures trading (in March, 2004) through July, 2007. So, from a longer-term perspective, VIX is not all that cheap.
Let us step back for a moment and discuss volatility theory, and then apply it to the current situation. VIX is often an accurate predictor of 30-day volatility, as it is designed to be. Occasionally due to emotions (or lack thereof), VIX can trade at extreme levels. In times of great volatility (last October, for example), VIX spikes up to great heights, fueled by nearly panic buying of S&P 500® Index put options. That may be a bullish signal for the stock market, as measured by S&P 500 Index. Conversely, when VIX produces a lower reading, it may indicate complacency in the stock market. Eventually, a market reaction can occur and often to the downside.
There is one other thing that is theoretically true regarding VIX, and that is it tends to trend opposite to the prevailing market. If the S&P 500 Index is rising, VIX will often be declining. Conversely, if the S&P 500 Index is falling, VIX will often be rising. This means that there exists a significant negative correlation between VIX and the S&P 500 Index. That, at least, is the underlying theory. Let us see how it applies in practice today. Some are saying that the VIX is too low, citing the fact that it is lower than it has been since late last summer. Traders may then extrapolate that piece of information to say that investors are complacent, possibly because of the low VIX and therefore danger may lie ahead.
Danger may indeed lie ahead, but it is not because VIX is predicting it. At the current time, we are more than two months into one of the strongest short-term rallies in memory. The S&P 500 Index rose nearly 40% from the March lows. As often occurs, VIX has declined while that rally has taken place. Moreover, since VIX is still declining (see Figure 1), one view is that it is still generally confirming a bullish outlook for the stock market. Therefore those who say VIX is too low could be wrong since historically VIX near 30 is not low. Moreover, as long as VIX continues to trend lower, that's often bullish for the broad market. Under this view, one might need to worry, or become more bearish, if VIX broke upward through its current downtrend. For example, at the present time, a rise in VIX to 34 or higher could be viewed as bearish.
In Figure 1, the blue line shows the downtrend in VIX that has been in force since the March S&P500 Index lows. The red line is the 34 level. A close above there would violate that downtrend line and could be evidence that the rally might be coming to an end.
Figure 1 Source: McMillan Analysis Corp.
Table 1 shows the premium on the VIX futures at the current time. As you can see, all of the futures are trading at a higher price than VIX. This could be viewed as somewhat bearish, although the timing of such signals is quite variable. But, in general, it could be evidence that the futures market feels that at least a temporary top is being made in the S&P 500 Index. This condition can persist for some time, but it is usually resolved by a rising VIX, which then shifts the futures to a discount.
Term Structure
Table 1 also shows the term structure of the VIX futures, which is the difference between the individual futures contracts. That term structure is quite flat at the current time. In fact, it has somewhat amazingly remained flat even as VIX has fallen over the past few weeks. Figure 2 is a chart of the futures contracts (colored lines) and VIX (green line). Note, that in a normal market environment, futures prices tend to differ from VIX nearly all the time. In fact, in a perceived crisis environment, like last October, those differentials were huge. But now, the futures are tightly banded about VIX and have been for several weeks even as VIX has fallen from the 40 level to the 30 level. This action is very rare, and perhaps unprecedented. The futures are hugging close to the VIX level, possibly suggesting that forward volatility is going to be the same as today's volatility.
One might put more credence in that projection if the VIX were trading in a flat line. But, the VIX is moving (lower), so are we supposed to believe that forward volatility is also adjusting lower at exactly the same rate all across the board? That could be unlikely and an incorrect prediction of where volatility will actually be when those forward dates arrive.
There may be one partial explanation for this and that is that the futures do not extend as far into the future as they normally have. At the current time, the longest-term futures and options expire in November, 2009, only six months hence. Previously, there had been expirations extending out 11 months. Only six consecutive months are being listed these days. While in the past, when we saw deviation between VIX and the longer-term futures, some of that may have been in months 7 through 11. Even so, the tightness in months 1 through 6 appears to be unprecedented.
A Potential Trading Strategy
Can this compacted situation be exploited as a potentially profitable trade? If so, it could have to do with trading the term structure. Eventually, something viewed as more normal could arise, with the longer-term contracts conforming to an average volatility, while the near-term contracts fluctuate either sharply higher or lower. Since traditional futures calendar spreads and option calendar spreads have unlimited risk that may not be a strategy one would want to employ in this situation. However, there is a way of playing the term structure with long options only that one could consider. Specifically, buy calls on near-term volatility and buy puts on longer-term volatility. Since all of the futures contracts are trading near 32, the 32.5 strike might be most appropriate. Consider this spread:
Buy June 32.5 call, recently trading at 3.30
Buy September 32.5 put, recently trading at 4.00
If the bear market resumes and VIX spikes higher, this hedge will easily make money as the June 32.5 calls have large profit potential in a rising volatility market, while the September puts can lose 4 points at most. What about a bull market, with a continuing decline in VIX? In that case, as VIX falls, the September puts should profit. Can they make enough to offset the loss in the June calls? That is the debatable question, but they can if longer-term SPX option traders become aggressive sellers of options as they lower longer-term volatility expectations.
The biggest problem for this spread would probably be a stable volatility structure for the next month. In that case, time value depreciation would hurt both options. The only way to minimize time value exposure would be to buy in-the-money options on both sides of the hedge (June 30 calls and September 35 puts, for example). However, that approach raises the overall debit and requires a large move to profit if a strong bull or bear market emerges. So, at-the-money options could be a way to position one, understanding that time decay is a major enemy of this position.
Figure 2 Source: McMillan Analysis Corp.
For more information on VIX and volatility futures including brokers, ISVs, symbols and product specifications, visit www.cboe.com/cfe |
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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Copyright © 2009 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.
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.
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