Using Volatility ETFs, ETNs and options Presented by Lawrence G. McMillan The Option Strategist TTThedge.com webinar June 4, 2012

Transcription

1 Using Volatility ETFs, ETNs and options Presented by Lawrence G. McMillan The Option Strategist TTThedge.com webinar June 4, 2012

2 McMillan Analysis Corp. A Derivatives Firm Recommendations (newsletters) Money Management (Volatility Capture strategy) Option Education (Mentoring)

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4 Today s Topics Review $VIX, futures, options $VIX ETN s (VXX, XIV, etc.) Being on the right side of the term structure Some interesting volatility ETN s Why NAV is important Cartoon credits: The New Yorker OptionsXpress Book of Cartoons

5 Implied Volatility (IV) A guess at volatility during the life of the option When IV is low, options are cheap but when it s high, they are expensive When IV rises, the option gets more expensive (Causes: large price drops, takeover rumors, FDA hearings, etc.).

6 $VIX CBOE Invention 1993: using 4 series of $OEX options renamed $VXO in 2003 conversion Created by Prof. Whaley, Duke Univ. Changed in 2003: uses strips of two nearest-term $SPX options, to create an average 30-day volatility

7 Current $VIX Chart

8 The VIX Formula VIX is a formula that can be applied to any entity with continuous option markets over all strikes So, as more and more VIX indices come along, they will be called Gold VIX, Oil VIX, etc. So, current VIX is really SPX VIX or S&P500 VIX

9 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE)

10 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE) Each volatility index above has its own symbol ($VIX for $SPX; $GDZ for GLD; etc.).

11 New $VIX Indices Currently, CBOE publishes VIX on: Commodities: Gold (GLD), Silver (SLV), Oil (USO), Euro FX (FXE) Stocks: Apple (AAPL), Amazon (AMZN), Goldman Sachs (GS), Google (GOOG), IBM (IBM) Markets: S&P 500 ($SPX), Emerging Mkts (EEM), China (FXI), Brazil (EWZ), Gold Mining Stocks (GDX), Energy Stocks (XLE) Each volatility index above has its own symbol ($VIX for $SPX; $GDZ for GLD; etc.). Just because an index is published, doesn t mean there are products to trade.

12 Trading Volatility Directly: New Volatility Products Futures on $VIX (2004) Options on $VIX (2006)

13 VIX Futures: Details One point move in VIX = $1000 move in futures Settlement: a.m. settlement on Wednesday Settlement day: 30 days prior to next option expiration Always a Wednesday Example: $SPX July options expire 7/20/2012 (3 rd Friday) 30 days back: 20 in July + 10 in June June has 30 days, so 10 days back is (Wed) 6/20/2012

14 Other VIX-like Futures Markets In U.S. $VXEEM (Emerging Markets): VXEM $VXEWZ (Brazil): VXEW $VXN (NASDAQ) most recent: VN $OIV oil, based on USO implieds futs & options $GVX gold, based on GLD implieds futs & options Europe: $VSTOXX vol futs & options Hong Kong: HSI vol futures Russia: RTS vol futures

15 A Problem With $VIX Futures? Both speculators and hedgers have sometimes been disappointed with muted movements in $VIX futures when $VIX makes a move. To counter this, stay short-term since $VIX is a 30-day measure.

16 Term Structure of Options

17 $VIX vs. $VIX Futures $VIX is based on two near-term series of $SPX options $VIX futures are based on one series of $SPX options, 30 days out There is a large difference in these two calculations

18 Example: $VIX vs. Futures

19 Term Structure Sept-Oct 2008

20 Options On Volatility ($VIX) Options on $VIX Index (not on futures) Launch date: 2/24/06 Just like options on $SPX, $OEX, etc. Expiration date: 30 days prior to next month s $SPX option expiration To price them with a model, they must be treated like futures options

21 $VIX Options New Product: launched 2/24/06 Cash-Based options on $VIX Are priced like futures options, however Open interest is large: 6.4 million (6/1/2012)

22 $VIX Call Options October 10, $VIX: Oct Nov Dec 25 Strike Calls Futures Ignore $VIX: the underlying for each option is the corresponding futures contract.

23 Some $VIX Option Strategies Behave Differently Calendar Spreads No longer have limited risk. Option 9/10/08 10/10/08 Futures Oct 25 call Oct: Nov 25 call Nov: Paid 0.40 for calendar spread. Loss is on 10/10/08!!

24 ETN s Simulating $VIX VXX*: uses two front-month futures (most popular) 58+Mil VXZ*: uses futs months 4 through 7 480,000 *: has listed options

25 ETN s Simulating $VIX VXX*: uses two front-month futures (most popular) 58+Mil VXZ*: uses futs months 4 through 7 480,000 Newer products: VIIX*/VIIZ: direct competitors with above ETN s 317K/300 VIXY*/VIXM*: direct competitors with above 1 Mil/44,000 *: has listed options

26 ETN s Simulating $VIX VXX*: uses two front-month futures (most popular) 58+Mil VXZ*: uses futs months 4 through 7 480,000 Newer products: VIIX*/VIIZ: direct competitors with above ETN s 317K/300 VIXY*/VIXM*: direct competitors with above 1 Mil/44,000 XIV/ZIV: reverse ETN s *: has listed options 15 Mil/12,000

27 ETN s Simulating $VIX VXX*: uses two front-month futures (most popular) 58+Mil VXZ*: uses futs months 4 through 7 480,000 Newer products: VIIX*/VIIZ: direct competitors with above ETN s 317K/300 VIXY*/VIXM*: direct competitors with above 1 Mil/44,000 XIV/ZIV: reverse ETN s TVIX/TVIZ: double the speed *: has listed options 15 Mil/12, Mil/2,500

28 ETN s Simulating $VIX VXX*: uses two front-month futures (most popular) 58+Mil VXZ*: uses futs months 4 through 7 480,000 Newer products: VIIX*/VIIZ: direct competitors with above ETN s 317K/300 VIXY*/VIXM*: direct competitors with above 1 Mil/44,000 XIV/ZIV: reverse ETN s 15 Mil/12,000 TVIX/TVIZ: double the speed 15 Mil/2,500 XVIX: based on the term structure 5,400 *: has listed options

29 ETN s and ETF s ETF is a basket of securities and can always be liquidated with proceeds returned to shareholders ETN is essentially subordinated debt of issuer, so if issuer goes bankrupt, holder of ETN would be a creidt in bankruptcy and would get back cents on the dollar Barclays is currently largest issuer of ETN s Only ETF s are VIXY and VIXM VXX & VIXY have performed identically

30 VXX underperforms $VIX

31 VXX

32 Reverse $VIX (symbol: XIV) Get it? VIX spelled backwards Conventional wisdom was Buy XIV to get benefit of continually rising term structure.

33 $VIX vs. XIV

34 VXX/XIV Trading System We want term structure to work for us (long XIV in bull market; long VXX in bear market) Use steepness of term structure as basis of system. Exit when term structure flattens Or when trailing stop is hit

35 VXX/XIV Trading System We want term structure to work for us (long XIV in bull market; long VXX in bear market) Use steepness of term structure as basis of system. Exit when term structure flattens Or when trailing stop is hit CURRENTLY FLAT Last trade was long XIV in December 2011, stopped out in April

36 Daily Reset: VXX vs. XIV Many ETF s and ETN s are reset daily Especially Ultras (short), 2x, 3x, etc. So they reflect each day s percentage move in whatever underlying they re tracking But over time, they might not

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38 Barclay s VEQTOR ETN: VQT Check daily at

39 VQT History

40 Current voracious appetite for volatility derivatives People are paying too much for protection. But by buying ETN s they don t realize it. ETN managers must buy $VIX futures (inflating premium). And must roll daily (steepen term structure).

41 Current voracious appetite for volatility derivatives People are paying too much for protection. But by buying ETN s they don t realize it. ETN managers must buy $VIX futures (inflating premium). And must roll daily (steepen term structure). Evidence: only U.S. has this distortion; only US has ETN s

42 Current voracious appetite for volatility derivatives People are paying too much for protection. But by buying ETN s they don t realize it. ETN managers must buy $VIX futures (inflating premium). And must roll daily (steepen term structure). Evidence: only U.S. has this distortion; only US has ETN s Causing distortions not seen before: $SPX down 10%; term structure positive. Result: underperformance of protection

43 Strategies to counter ETN Effect: 1 If $VIX Futures have too much premium: Sell $VIX futures, and Sell $SPX-like futures If use futures, have to buy some $SPX-like calls in order to counter risk of rising $VIX and rising $SPX (rare, but not impossible) Or buy puts on both (safer)

44 Strategies to counter ETN Effect: 2 If $VIX Futures term structure too steep Sell far month, buy near month And buy $SPX-like calls as a hedge to further increase in term structure steepness

45 Other Dangers: ETN NAV TVIX: Double speed VXX Demand so large that underwriter, Credit Suisse, stopped issuing new shares in February TVIX then traded well above Net Asset Value

46 Other Dangers: ETN NAV TVIX: Double speed VXX Demand so large that underwriter, Credit Suisse, stopped issuing new shares in February TVIX then traded well above Net Asset Value When CS resumed issuing new shares, TVIX plunged to NAV in just 2 days. Large losses occurred for the uninformed masses.

47 TVIX vs. VXX

48 Check NAV on Bloomberg Type TVIX (or other symbol) Scroll down for NAV Would have cured TVIX problem, But NAV is inflated for most ETNs now because they have forced $VIX futures into an over-priced state.

49 XVIX: Term Structure ETN Issued by UBS XVIX = 2*VXZ VXX In backtesting, this rose during bull and bear markets. It was unclear why this particular formula is supposed to track the term structure, but it seemed to be a money-maker when introduced. However, since then it has not done well, so this ETN should be avoided.

50 XVIX

51 Useful addresses for volatility info: Vixandmore.blogspot.com Onlyvix.blogspot.com

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