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: Announcements and Calendar, 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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Contact Information

Please direct questions concerning this circular to Jay Caauwe at (312) 786-8855 or caauwe@cboe.com.

VIX Futures Last Trade Dates

Announcements

"VIX FUTURES AND OPTIONS: A CASE STUDY OF PORTFOLIO DIVERSIFICATION DURING THE 2008 FINANCIAL CRISIS" RELEASED

A recently released University of Massachusetts study found that certain investments in futures and options on the CBOE Volatility Index^® (VIX^®) could have reduced downside risk for a typical institutional investment portfolio during the 2008 financial crisis.

Settlement Information

The Final Settlement Price for VIX Futures is determined from a Special Opening Quotation (SOQ) of VIX. The SOQ is calculated from the sequence of opening prices of the SPX options used to calculate the VIX index on the settlement date (the "Constituent Options"). The opening prices for SPX options used in calculating the SOQ are determined through an automated auction mechanism ("Hybrid Opening System" or "HOSS") that matches buy and sell orders residing on the Electronic Order Book prior to the opening of trading. We ask that all market participants review the procedures pertaining to settlement

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.

Volatility Expectations Are Lowering

In the last few months, traders have paid large premiums for the CBOE Volatility Index^® Futures ("VIX"^®), which may be due to the expectation that September and October would be their usual bearish selves. Stock owners seemingly were paying up quite heavily for either the S&P 500^® Index ("SPX^SM options") puts, whose implied volatility drives the price of VIX futures, or for VIX futures themselves. As it turned out, those worries were unfounded. The S&P 500 Index has continued to rally and even gain strength. As a result, the September VIX futures and options which expired on Wednesday, September 16, settled at a price of 23.64. That settlement was just above July's settlement of 23.48 and is the second lowest settlement since June of 2008.

As a result of this relatively low settlement on the cash VIX, the hedges in September futures and options that were set up over the past couple of months expired for the most part worthless. Of course if they were truly hedges, then the product they were hedging, stock for example, realized a profit during the S&P 500 Index rally.

The premiums on the VIX futures have diminished in the last two weeks or so, as the demand for the S&P 500 Index puts has waned with the latest move to new post-March highs. For example, the October futures, now the front month and the seat of the most activity, have seen their premium drop to less than 2.50 points, whereas it was over 5 not that long ago. As an example, when we noted this in last month's newsletter, the October futures premium was 4.99.

Table 1 shows the current levels of VIX futures premium. You can see that the October premium is now much lower than the others. This partly reflects the fact that October expiration is the nearest one and, of course, the premium will converge by expiration.

                                              Source: MAC

Term Structure

In Table 1, note that the November and later contracts are still trading with healthy premiums. Thus the term structure, the relationship between the various VIX futures contracts, continues to slope upward. Figure 1 shows the term structure of all the current VIX futures contracts (red line). It also shows the term structure from late August (green line), so that you can compare how the term structure has moved and changed since then. At the current time, the term structure more or less rises steadily from one month to the next. One exception is a slight downward lean in December, as there is almost every year. But in late August, the term structure clearly showed October as its high point as traders seemed to be preparing for a October market downfall and were paying up for protection in that month. Seemingly that fear has dissipated, and the term structure is more typical for an ongoing bull market. Also, Figure 1 clearly shows that not only has the term structure flattened but that futures prices are lower across the board as well.

Figure 1                                               Source: McMillan Analysis Corp.

Trading Strategies

The current level of October premium, 2.40 (see Table 1), is still rather hefty. Usually traders would not pay much above VIX for the near-term futures. So, strategies meant to employ that premium as an edge should still work. It's just that they are not as attractive as they perhaps were a few weeks ago.

Speculation

At the risk of being repetitive, remember that when the futures are inflated in price, there are two basic strategies that can employ that fact as an edge. The first is a simple purchase of VIX puts. It is as if you get a head start on a downside move in VIX. Even if VIX rises, the futures might not, since they already demonstrate a premium over the index.

Hedging

The hedged version is to buy the VIX puts and to also buy the S&P 500 Index puts as a hedge, generally in a ratio of about 2 VIX puts for each S&P 500 Index put. In September, the September VIX futures held their premium for quite a while, but eventually fell heavily going into expiration, so the strategy had to be held to terminus. In other past months the premium has disappeared much more quickly, and the strategy would yield quicker results.

Term Structure Strategies

Another strategy that might be attractive is one employing the term structure's steepness. This is a much more speculative approach, because one does not have a built-in edge, as in the above strategies. In addition, the term structure can actually invert, so no matter at what level you establish a term structure trade, your risk is theoretically quite large. Will the October futures continue to feel the weight of pending expiration, even if it is still almost five weeks away? If so, then selling October and buying November would likely be the correct strategy.

On the other hand, if you are more bearish on the stock market, you might think that the term structure will flatten out. It will likely flatten if this rally terminates and a market decline begins, although perhaps not right away. In the two brief corrections that we have seen since this latest bullish phase began in early July, the term structure only flattened modestly and briefly. Nevertheless, a bearish trader might want to buy October VIX futures and sell November VIX futures. In either case, the risk of the strategy can be mitigated by using options instead of futures. That is, replace the long future with an in-the-money long call, and replace the short future with an in-the-money long put.

In summary, the term structure strategies are much more risky and are really for the more experienced and/or aggressive traders. The strategies based on the premium have the built-in edge, and while that certainly does not eliminate risk, it does reduce it a bit.

VIX – Fact & Fiction

Hailed as a revolutionary benchmark when it was first introduced by CBOE in 1993, the CBOE Volatility Index^® (VIX^®) rapidly gained traction as the preeminent barometer for measuring market volatility. VIX soon was closely followed, widely quoted, and highly publicized, but never more so than in the recent past as investors looked to VIX and other indicators for insights to a global market meltdown and record levels of sustained volatility. Amidst heightened investor and media attention, it became evident that some market observers were making overly generalized interpretations of VIX, or were look­ing to VIX for information it was not designed to convey. The purpose of this Research Note is to explore five common misconceptions (see "Myths" below) that have surfaced about VIX and, in the process, to separate fact from fiction.

Myths (Acrobat).

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.

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.