CBOE Volatility Index and VIX Futures Trading Russell Rhoads, CFA Disclosure In order to simplify the computations, commissions have not been included in the examples used in these materials. Commission costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Multiple-leg strategies involve multiple commission charges. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. Investors considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions. CBOE and Chicago Board Options Exchange are registered trademarks and The Options Institute is a servicemark of CBOE. All other trademarks and servicemarks are the property of their respective owners. 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 Chicago Board Options Exchange, Incorporated. All rights reserved. 2
VIX and VIX Futures Trading Volatility Primer CBOE Volatility Index Volatility Risk Premium Performance by Strategy VIX Futures Trading the Curve Short Term Trading Links / Contact Info 3 Historical vs. Implied Volatility Two Types of Volatility* Historical Volatility based on past stock price changes Implied Volatility expected volatility based on option market pricing 4
Historical vs. Implied Volatility Six Option Pricing Factors Price of Stock Option Strike Price Time Until Expiration Interest Rates Dividends Implied Volatility 5 Historical vs. Implied Volatility Option Pricing Calculator Inputs Price 51.00 Strike 50.00 Days to Exp. 30 Dividends 1.95% Interest Rate 1.00% Volatility 25% Output Call Put Theo Price 1.90 1.10 Where does this number come from? 6
Historical vs. Implied Volatility Option Pricing Calculator Inputs Price 51.00 Strike 50.00 Days to Exp. 30 Dividends 1.95% Interest Rate 1.00% Call Price 2.00 Output Volatility 30% Implied Volatility comes from the Option Price 7 CBOE Volatility Index The CBOE Volatility Index or VIX is a consistent 30 day measure of implied volatility as indicated by S&P 500 Index option prices The VIX Methodology is considered the industry standard for a consistent measure of implied volatility Historically VIX has displayed an inverse relationship with the S&P 500 which resulted in it being referred to as the fear index 8
CBOE Volatility Index VIX vs. S&P 500 2550 25 2500 2450 2400 S&P 500 23 21 19 2350 2300 2250 2200 VIX 17 15 13 2150 11 2100 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 9 Data Source: Bloomberg 9 CBOE Volatility Index 3.50 S&P 500 Put / Call Ratio 3.00 Put Volume > Call Volume 2.50 2.00 1.50 1.00 0.50 Call Volume > Put Volume 0.00 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 10
CBOE Volatility Index VIX High Low Average by Year 90 80 70 60 50 40 30 20 10 0 1990 1995 2000 2005 2010 2015 11 Volatility Risk Premium VIX vs. SPX Realized Volatility 18 16 14 VIX 12 10 8 6 4 SPX Realized Vol 2 0 1/3/17 2/1/17 3/2/17 3/30/17 4/28/17 5/26/17 6/27/17 Data Source: Bloomberg and www.cboe.com 12
Volatility Risk Premium VIX vs. SPX Realized Volatility 100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50% -10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35+ Data Source: Bloomberg 13 Volatility Strategy Performance Volatility Strategy Indexes CBOE Eurekahedge Short Volatility Index CBOE Eurekahedge Long Volatility Index CBOE Eurekahedge Relative Value Volatility Index CBOE Eurekahedge Tail Risk Index 14
Volatility Strategy Performance Eurekahedge Indexes Return of $100 Jan 2008 Sep 2017 210 190 170 Relative Value $198 Short Volatility $169 Long Volatility $164 Tail Hedge $59 150 130 110 90 70 50 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Data Source: Bloomberg 15 VIX Futures Contract Specifications The value of a VIX futures contracts is $1000 times the quoted value Minimum ticks are 0.05 ($50) for single contract trades and 0.01 ($10) for calendar spreads There are both standard and weekly contracts available for trading currently the majority of volume is concentrated in the standard expirations Trading is available almost 24 / 5 with small breaks after the end of regular US trading hours Expirations typically occur on Wednesdays and the futures are AM settled 16
VIX Futures Pricing Unlike many financial futures markets there is not a fair value relationship between VIX and the associated futures contracts At times VIX futures are priced at a premium to spot VIX and at times VIX futures will be priced at a discount The pricing relationship is often referred to as being in contango or backwardation 17 VIX Futures Contango / Backwardation VIX Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 18
VIX Futures Backwardation Impact of Brexit Referendum 26 24 22 Friday 6:30 AM Chicago 20 18 Thursday US Closing 16 VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 19 VIX Futures Standard Futures Daily Pricing 28 Dec Front Month 24 20 Dec 2015 VIX Future 16 Spot VIX 12 9/16 10/7 10/28 11/18 12/10 20
VIX Futures Contango / Backwardation by Year VIX Index Higher than Month 1 Month 1 Future Higher than Month 2 VIX - Month 1 - Month 2 Backwardation SPX Performance Year 2007 39.04% 29.48% 21.12% 3.53% 2008 45.45% 48.62% 35.18% -38.49% 2009 23.81% 26.98% 9.92% 23.45% 2010 20.24% 6.35% 6.35% 12.78% 2011 27.78% 30.95% 14.68% 0.00% 2012 9.20% 0.80% 0.00% 13.41% 2013 13.10% 3.57% 3.17% 29.60% 2014 17.86% 10.32% 9.13% 11.39% 2015 17.46% 19.05% 12.70% -0.73% 2016 13.10% 14.29% 8.73% 9.54% 21 Calendar Spreads Strategy Overview VIX Futures contracts are often spread against each other with the near month typically being sold Two common instances of selling VIX futures stem from an expectation for VIX to move lower or for futures to drift lower along the curve 22
Calendar Spreads Trading the Curve Term Structure on Friday July 1 22 20 VXU6 @ 19.30 VXV6 @ 19.90 18 16 14 VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 23 Calendar Spreads Trading the Curve Term Structure on Friday July 1 Sell September VIX at 19.30 Buy October VIX at 19.90 24
Calendar Spreads Trading the Curve Term Structure on Friday August 12 22 20 18 16 VXU6 @ 14.95 VXV6 @ 16.70 14 12 10 VIX Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 25 Calendar Spreads Trading the Curve Term Structure on Friday August 12 Short September VIX at 19.30 down 4.35 to 14.95 Long October VIX at 19.90 down 3.20 to 16.70 Net Profit = +1.15 26
Calendar Spreads Fading a Spike Friday June 24 VIX up 30% to 25.76 26 24 VXN6 @ 22.65 22 VXQ6 @ 22.10 20 VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 27 Calendar Spreads Fading a Spike Friday June 24 VIX up 30% to 25.76 Sell July VIX at 22.65 Buy August VIX at 22.10 28
Calendar Spreads Friday July 1 VIX Curve Back in Contango 26 24 June 24 Curve 22 20 18 16 VXN6 @ 16.80 VXQ6 @ 18.25 July 1 Curve 14 VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 29 Calendar Spreads Friday July 1 VIX Curve Back in Contango Buy July VIX at 16.80 (+5.85) Sell August VIX at 18.25 (-3.85) Net Gain = +2.00 30
Calendar Spreads June 13 VIX Term Structure Flat 24 22 VXN6 @ 21.25 20 VXQ6 @ 21.25 18 VIX Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 31 Calendar Spreads June 13 VIX Term Structure Flat Sell July VIX at 21.25 Buy August VIX at 21.25 32
Calendar Spreads Friday June 24 VIX up 30% to 25.76 26 24 VXN6 @ 22.65 22 20 VXQ6 @ 22.10 18 VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 33 Calendar Spreads Friday June 24 VIX up 30% to 25.76 Short July VIX at 21.25 now up 1.40 to 22.65 Buy August VIX at 21.25 now up 0.85 to 22.10 Current P/L = -0.65 Short July Leg = -1.40 34
Calendar Spreads Friday June 24 VIX up 30% to 25.76 July VIX Intraday High = 27.65 August VIX Intraday High = 25.65 Short July VIX Intraday Max Loss = 6.40 Calendar Spread Intraday Max Loss = 2.00 35 Short Term VIX Spreads Common Day Trade Structures Calendar Spread Usually short near month / long farther month Butterfly Spread Usually short near month and farther month Long expiration between short months 36
Short Term VIX Spreads Calendar Spread October 21, 2016 Market Open Short Nov VIX at 16.00 Buy Dec VIX at 16.80 Market Close Cover Nov VIX at 15.50 (+0.50) Sell Dec VIX at 16.50 (-0.30) Net Result +0.20 37 Short Term VIX Spreads Butterfly Spread November 11, 2016 Market Open Short 1 Nov VIX at 16.05 Buy 2 Dec VIX at 16.70 Short 1 Jan VIX at 17.70 Market Close Cover 1 Nov VIX at 15.00 (+1.05) Sell 2 Dec VIX at 16.10 (-1.20) Cover 1 Jan VIX at 17.30 (+0.40) Net Result +0.25 38
VIX Futures Trading Summary VIX and the S&P 500 have historically had an inverse relationship VIX futures do not have a fair value relationship between the spot index like most other financial futures contracts Due to the narrow tick size for calendar spreads these types of trades are popular with short term traders 39 Useful Links / Contact Information Links www.cboe.com/vix www.cfe.cboe.com www.cboe.com/blogs Contact Information Russell Rhoads, CFA rhoads@cboe.com Twitter - @RussellRhoads 40