Options and Volatility Benchmarks & Indicators Cboe Risk Management Conference Asia. John Hiatt

Transcription

1 Options and Volatility Benchmarks & Indicators Cboe Risk Management Conference Asia John Hiatt December 5, 2017

2 Using options benchmarks & volatility indicators

3 Using options for benchmarks & volatility indicators Footnotes applied here Measure of Investor Sentiment Cboe Volatility Index (VIX ) Cboe S&P 500 Implied Correlation Indexes (ICJ, KCJ, JCJ) Cboe SKEW Index (SKEW SM ) Inputs for Algorithmic Asset Allocation Strategy Morgan Stanley High Yield + Index CBOE Applied Academics TYVIX/VIX - based Asset Rotation Strategy (Stabilis) Option Strategy Benchmarks Cboe Russell 2000 BuyWrite Index (BXR) Cboe Russell 2000 PutWrite Index (PUTR) Cboe Russell 2000 Conditional BuyWrite Index (BXRC) Cboe Russell Delta BuyWrite Index (BXRD) 3

4 Comparison of CBOE Russell 2000 PutWrite Index (PUTRSM) and CBOE Russell 2000 BuyWrite Index (BXRSM)

5 Breaking the Law of Put / Call Parity? Despite high correlation, CBOE Russell 2000 PutWrite Index (PUTR SM ) substantially outperforms CBOE Russell 2000 BuyWrite Index (BXR SM ) Differences in methodology between the PUTR and BXR matter a great deal and explain the performance difference RUT BXR PUTR SPX BXM PUT Data provided January 31, 2001 through November 15, 2017 Source: Cboe Multi Asset Solutions 5

6 BXR & PUTR Index Methodologies Compared BXR PUTR Exposure Long Russell 2000 Index (RUT) Short 1M RUT at-the-money call option 1M Treasury Bill (Cash) Short 1M RUT at-the-money put option Dividends Re-invested in BXR units on dividend ex-dates No dividends to re-invest; expected dividend priced into put option Option Roll 3rd Friday every month Expiring option settles to cash based on Special Opening Quotation ( SOQ ) of RUT New option strike based on RUT level at 11 a.m. ET New call struck just above RUT 11 a.m. ET level 3rd Friday every month Expiring option settles to cash based on Special Opening Quotation ( SOQ ) of RUT New option strike based on RUT level at 11 a.m. ET New put struck just below RUT 11 a.m. ET level Option Sale Deemed sold based on 30-minute VWAP from 11:30 a.m. 12:00 noon Deemed sold based on 30-minute VWAP from 11:30 a.m. 12:00 noon Detailed discussions of the methodology applied for both indexes is available in the respective white papers on Cboe s website: 6

7 Exploring BXR & PUTR Methodology Differences Strike prices for RUT call and put options are not the same Call strike for BXR just above RUT level at 11 a.m. ET; call is slightly out of the money Put strike for PUTR just below RUT level at 11 a.m. ET; put is slightly out of the money PUTR put implied volatility is consistently higher than BXR call implied volatility Option Roll Mechanics & Expiration Day Effects Historically, SOQ for index options has exhibited an upward bias Dealers, market makers tend to be sellers of index puts and buyers of index calls, making them long the market Unwinding hedges at expiration tends to create buy imbalances in stocks Footnotes applied here 7

8 Expiration Day Effects Expiration Day Return Calculation BXR R BXR, EXP = R A x R B x R C ;where R A = Return from previous close to SOQ R B = Return from SOQ to VWAP option sale long stock position uncovered R C = Return from VWAP option sale to expiration day close BXR PUTR R PUTR, EXP = R A x R GAP x R B ;where R A = Return from previous close to SOQ R GAP = Period from SOQ to VWAP option sale cash position uncovered R B = Return from VWAP option sale to expiration day close PUTR R A (Option On) 0.081% 0.058% R B or R GAP (Option Off) % R C (Option On) 0.089% 0.039% Expiration Day Return - R % 0.097% Analysis based on data from May 2006 through August 2017 Source: Cboe Multi Asset Solutions 8

9 CBOE Applied Academics TYVIX/VIX - based Asset Rotation Strategy (Stabilis)

10 Origin of Stabilis CBOE/CBOT 10-Year US Treasury Note Volatility Index (TYVIX) TYVIX is the conceptual analogue of VIX for the US Treasury market: a transparent benchmark measuring the fair market value of constant 30-day forward volatility of the benchmark 10-year US Treasury Note futures prices implied by options on 10-year US Treasury Note futures Morgan Stanley High Yield + Index (ticker: MSUSHP5T Index ) A long-only, rules-based strategy which aims to generate a return by applying dynamic allocation between the ishares iboxx H/Y Corporate Bond Fund (ticker: HYG), ishares Barclays 20+ Year Treasury Bond Fund (ticker: TLT) and a Cash Rate. 1 CBOE Applied Academics TYVIX/VIX - based Asset Rotation Strategy (Stabilis) Stabilis is a conceptual analogue to the Morgan Stanley High Yield+ Index that applies a dynamic allocation between SPDR S&P 500 ETF (ticker: SPY), ishares Core U.S. Aggregate Bond ETF (ticker: AGG), ishares 7-10 Year Treasury Bond ETF (ticker: IEF) and cash based on the levels of VIX and TYVIX. It is beneficial to use implied volatility indices for timing asset allocation because the relative movement of equity and bond implied volatilities has historically predicted the relative performance among major asset classes. 1MORGAN STANLEY HIGH YIELD+ INDEX SUPPLEMENT (To Prospectus dated November 19, 2014)); Registration Statement No

11 Volatility Regimes: Separating markets by volatility regimes A simple high/low volatility regime model effectively captures VIX spikes. The regimes are defined based on upward- and downwardcrossings of rolling upper and lower quantiles of VIX and TYVIX. More details can be found at: Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. 11

12 ANNUALIZED RETURN 03/ /2017 Combined VIX and TYVIX Regimes: Return separation FOR EACH REGIME The simple volatility regimes effectively separate returns in an economically intuitive way. In the LL ( normal ) regime, equities perform best, followed by corporates then Treasuries, and the order is reversed in the HH regime. In the HL regime, equities perform well while fixed income does not, and Treasuries do better than corporates in the LH regime. RETURN DECOMPOSITION BY REGIME S&P500 US Aggregate Bond US Treasury 7-10Year US Treasury Bill 0-3Month 15.47% 16.72% 15.81% 15.32% 7.32% 6.13% 4.16% 3.42% 1.35% 0.77% 1.37% 1.42% 1.16% -2.16% -6.19% -9.29% TYVIX HIGH/VIX HIGH (979 DAYS) TYVIX HIGH/VIX LOW (373 DAYS) TYVIX LOW/VIX HIGH (578 DAYS) TYVIX LOW/VIX LOW (1425 DAYS) Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. Data from March 2004 to September

13 Stabilis STRATEGY Allocations by regimes Regime 1: Broad Market Calm TYVIX VIX Regime 2: Isolated Anxiety in Bond Markets TYVIX VIX Regime 3: Isolated Anxiety in Equity Markets TYVIX VIX Regime 4: Broad Market Panic TYVIX VIX EQ 20% EQ 20% EQ 10% EQ 10% TSY 10% CORP 20% CORP 70% CORP 70% CASH 70% TSY 70% TSY 10% TSY 20% EMPIRICAL BUILDING BLOCKS Historically risk assets perform well during broad market calm, and portfolio aims to be approximately equally risk weighted bonds significantly underperform equities when there s isolated anxiety in bond markets the most severe risk asset drawdowns happen during broad market panics equities underperform and there s a flight-to-quality into Treasuries in a broad market panic Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. 13

14 Stabilis STRATEGY Historical Cumulative Performance Stabilis US has significantly higher risk adjusted returns compared to a steady 60% equity / 40% bond allocation Stabilis US 60% Equity / 40% Bond Stabilis US 60/40 Fund Annualized Return (%) 5.75% 6.91% Volatility (%) 4.28% 10.99% Sharpe Ratio Max Drawdown 11.2% 36.3% Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. Data from April 1, 2004 to August 31,

15 VIX ETP Market Review

16 Over $5 Billion in ETP assets influence VIX futures market Top 5 ETPs account for approximately 75% of assets and the top 10 ETPs account for over 95% There are four strategies that are the most popular: long constant 30-day VIX future (VXX*), 2X long 30-day VIX future (TVIX, UVXY*), short 30-day VIX future (XIV, SVXY*) and conditional 30-day VIX future (PHDG,VQT) Two structures of VIX ETPs have different effects on VIX futures market (ETF vs. ETN) Distribution of ETP assets is highly volatile and depends on market factors such as level of VIX and shape of VIX term structure Distribution of Volatility ETP assets on 21-Apr-16 $ $1, $1, $ $1, $ $ VXX UVXY XIV TVIX SVXY NEXT 5 Rest 16

17 Feb-09 May-09 Aug-09 Nov-09 Feb-10 May-10 Aug-10 Nov-10 Feb-11 May-11 Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb-17 May-17 Aug-17 Nov-17 ETP Assets ($MIL) Volatility ETPs Impact on VIX Futures Open Interest Footnotes applied here History of Volatility ETP Assets 6,000 5,000 4,000 3,000 TVIX, VELOCITYSHARES 2X VIX S/T XIV, VELOCITYSHARES INV VIX S/T launched November 30, 2010 VXX, IPATH S&P 500 VIX S/T ETN launched January 29, , , , , ,000 2, ,000 1,000 - SVXY, PROSHARES INV VIX S/T ETF UVXY, PROSHARES 2X VIX S/T ETF launched October 4, , ,000 0 Top 5 Next 5 Rest VIX OI 17

18 VXX Exposure Example Futures Exposure Future Open Interest Vega Mar-14 UXH4 177, ,340,000 Apr-14 UXJ4 60,755 60,755,000 Future Futures Price Futures Weight Mar-14 UXH X Apr-14 UXJ Constant Maturity Future VXX Price Vega per ETN share Mar-14 Future Vega per ETN share Futures Weight ETN Exposure Vega per ETN share ETN Shares Oustanding Vega UXH ,286, X X 21,035,990 Apr-14 UXJ ,050,596 18

19 Estimated ETP Volume Example of ETP effect on VIX Futures Volume Footnotes applied here Cboe Estimate of Proshares VIX Futures Volume 50, , , , , SVXY UVIXY VIXY Front Month VIX Future 19

20 Around $4.9 Billion in ETP assets on November 30 Top 5 ETPs now account for approximately 85% of assets and the top 10 ETPs still account for over 95% Overall, ETP assets down approximately 16%, from about $5.7 to $4.9 Billion Biggest change since April 2016 is the prominence of short volatility ETPs, which now account for over $2.2 Billion in assets Leveraged VIX ETP assets halved from $1.6 Billion to just under $800 Million Distribution of Volatility ETP assets on 30-Nov-17 $ $ $1, $ $ $1, $ VXX UVXY XIV TVIX SVXY NEXT 5 Rest 20

21 Estimated ETP Volume Estimated ETP Volume Short Volatility Trade in 2017 AUM and Price Return in XIV and SVXY Short ETP Assets SVXY XIV VIX Daily Contango in VIX futures

22 Disclaimer Cboe, Cboe Volatility Index and VIX are registered trademarks of Cboe. BuyWrite SM, Cboe/CBOT 10-year U.S. Treasury Note Volatility Index SM,TYVIX SM, CBOE Russell 2000 BuyWrite Index (BXR SM ) and CBOE Russell 2000 PutWrite Index (PUTR SM ) are servicemarks of Cboe. Standard & Poor's, S&P, S&P 500, and Standard & Poor's 500 are trademarks of Standard & Poor's Financial Services, LLC and have been licensed for use by Cboe Exchange, Inc. (Cboe). S&P makes no representations or recommendations concerning the advisability of investing in products that have S&P indexes as their underlying interests. Russell and Russell 2000 are registered trademarks of the Frank Russell Company, used under license. 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. Copies are available from your broker, by calling OPTIONS or from the Options Clearing Corporation at The information in this presentation is provided solely for general education and information purposes. No statement within this presentation should be construed as a recommendation to buy or sell a security or to provide investment advice. The CBOE Russell 2000 BuyWrite Index (BXR) and CBOE Russell 2000 PutWrite Index (PUTR) (the Indexes ) are designed to represent proposed hypothetical buy-write and put-write strategies. Like many passive benchmarks, the Indexes do not take into account significant factors such as transaction costs and taxes. Transaction costs and taxes for the strategies could be significantly higher than transaction costs for a passive strategy of buying-and-holding stocks. Investors attempting to replicate the Indexes should discuss with their brokers possible timing and liquidity issues. Past performance does not guarantee future results. These materials contain comparisons, assertions, and conclusions regarding the performance of indexes based on backtesting, i.e., calculations of how the indexes might have performed in the past if they had existed. Backtested performance information is purely hypothetical and is provided in this document solely for informational purposes. Backtested performance does not represent actual performance and should not be interpreted as an indication of actual performance. Parameters relating to past performance of strategies discussed are not capable of being duplicated. No representation is being made that any investment will or is likely to achieve a performance record similar to that shown. The methodology of the Indexes is owned by Chicago Board Options Exchange, Incorporated (CBOE). This presentation should not be construed as an endorsement or an indication by CBOE of the value of any non-cboe product or service described in this presentation. Copyright 2017 Cboe Global Markets All rights reserved. 22

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