Developments in Volatility-Related Indicators & Benchmarks

Developments in Volatility-Related Indicators & Benchmarks William Speth, Global Head of Research Cboe Multi-Asset Solutions Team September 12, 18

Volatility-related indicators unlock valuable information in options prices Options reflect expected risk in the future, and the market price of protecting against that risk The Cboe Volatility Index (VIX Index) combines prices of hundreds of SPX SM options to provide a single, standardized benchmark for 3-day expected volatility of S&P 5 Other options-based indicators and benchmarks provide a more nuanced and complete view of expected risk: Other Volatility Benchmarks Cboe Russell Volatility Index Volatility of Volatility Cboe VVIX SM Index Skew Cboe SKEW SM Index, 9%-11% IV & Credit Suisse Fear Barometer Term Structure VIX futures, SPX implied volatility, VVIX & SKEW Correlation Cboe S&P 5 Implied Correlation Indices Can be tradable or used to generate trading signals 2

The VIX Index & Other Volatility Benchmarks

What is the VIX Index? The VIX Index is an up-to-the-minute market estimate of 3-day expected volatility of the S&P 5 Index that is calculated by using the midpoint of real-time SPX option bid/ask quotes The VIX Index methodology isolates pure volatility exposure directly from option prices The VIX Index was designed as an underlying for tradable products. The VIX Index reflects what investors are actually paying for protection rather than how they are feeling about risks generally VIX vs. SPX Long term negative correlation with SPX returns (-.7); with short term variability VIX Index moves are convex to SPX; some of the largest VIX % moves have taken place during low volatility 8% 6% 4% % VIX Return The VIX Index tends to spike in response to sharp down moves; falls more slowly in rising markets SPX Return % -15% -1% -5% % 5% 1% 15% Source: Cboe -% -4% 4

Other things you should know about the VIX Index The portfolio of SPX options comprising the VIX Index changes every minute The range of strikes used in the VIX calculation is dynamic and is determined by the zero-bid rule As implied volatility increases, more OTM puts / calls become bid and the strike range increases As implied volatility falls, more OTM puts / calls have no bids and the strike range decreases SPX strike range for VIX level of 3 85% of ATM SPX; SPX strike range for VIX level of 15 63% of ATM SPX Option skew can have a large influence on the level of the VIX Index 3 Vol Normal Probability Distribution SPX Option/Prices Used to Calculate Different VIX Index Levels 15 Vol $ -7% -6% -5% -4% -3% -% -1% % 1% % 3% Puts VIX = 3 $6 $5 $4 $3 $ $1 Moneyness Option Price VIX = 15 Calls 5

RVX RUT Cboe Russell Volatility Index (RVX SM ) The RVX Index is calculated using the VIX methodology applied to Russell Index (RUT) options RVX is negatively correlated to RUT returns (-.7) but, like the VIX Index, with short term variability 1 8 6 4 Relationship of RVX & RUT RVX RUT 19 14 9 4 8% 6% RVX Return -.25 Rolling 1M Correlation -.5 4% -.75 % -1 RUT Return % -12% -8% -4% % 4% 8% 12% -% -.25 -.5 -.75 Rolling 3M Correlation -4% -1 4 6 8 1 12 14 16 18 Source: Cboe 6

Equity volatility indicators are not the same Historically, RVX and VIX have moved together; RVX has generally been priced higher than VIX Since 12, the premium of small cap to large cap volatility has declined At the same time, historical correlation of RVX & VIX has broken down 1 8 6 4 12 1 8 6 4 2-2 1.9.8 VIX RVX Difference of VIX & RVX (Rolling 3M Average).7 Source: Cboe.6 RVX/VIX Rolling 3M Correlation.5 4 6 8 1 12 14 16 18 7

Volatility of Volatility (VVIX)

Beta What is VVIX? The Cboe VVIX Index ( VVIX ) measures volatility of volatility in this case, expected volatility of the 3-day forward price of the VIX Index - the price of a hypothetical VIX futures contract that expires in 3 days VVIX is calculated using the VIX methodology applied to near- and nextterm VIX options Source: Cboe VVIX is not the same as the expected volatility of the spot VIX Index, but the two are related Beta of 3-day forward VIX to spot VIX.5 Since 7, average VVIX value is 89 vs. spot VIX volatility of 128 1..9.8.7.6.5.4.3..1. Beta of VIX Futures to the VIX Index R² =.9219 21 42 63 84 15 126 147 168 189 21 231 252 VIX Futures Days to Expiration 9

VVIX VIX Properties & Uses of VVIX VVIX can be used to estimate risk premium of VIX options; expected variability of VIX Index values; an input to determine VIX futures FV VVIX and VIX Index returns are positively correlated.8 Highest 1% of VVIX values associated with Avg. VIX Index value of 28; 6 of highest VVIX values occurred in February 18 (record 18 on Feb 8) 8% VVIX Return 14 1 Avg. VVIX Avg. VIX 3 6% 1 25 4% R² =.6455 % VIX Return % -5% % 5% 1% 15% 8 6 4 15 -% 1 2 3 4 5 6 7 8 9 1 1 Source: Cboe -4% VVIX Decile 1

What can you buy for 5 cents? Impact of VVIX on VIX Option Pricing VVIX VIX options :: VIX SPX options Holding VIX futures constant, what is the VIX call strike price closest to 14 that I can buy for $.5 at different VVIX levels? 29 VVIX reflects demand for VIX options, including VIX calls used for tail hedge protection 18 22 When VVIX is high, traders need larger move in VIX in order for hedge to break even VVIX @ 8 VVIX @ 1 VVIX @ 1 Need 32% VIX move to break even Need 61% VIX move to break even Need 111% VIX move to break even 11

VVIX VIX Is volatility of volatility predictive? VVIX has tended to be more correlated to the VIX Index since 1 Divergence in Q3/Q4 17 signaled volatility regime change in February 19 9 17 8 7 15 6 13 5 11 4 9 7 3 1 5 7 8 9 1 11 12 13 14 15 16 17 18 VVIX VVIX D MA VIX VIX D MA January 7 through August 18 Source: Cboe 12

Skew Indicators

5 6 7 8 9 1 11 1 13 6 7 8 9 1 11 1 13 14 7 8 9 1 11 1 13 14 15 What is Skew? The difference between an observed price distribution and a theoretical normal distribution, whether large moves are more likely on the downside or upside. Option prices generally reflect the price of expected risk; OTM option prices reflect tail risk 3 28 26 24 22 18 3 28 26 24 22 18 3 28 26 24 22 18 Strike Strike Strike 14

Measuring Skew with Options Cboe S&P 5 Skew Index (SKEW SM ) - derives expected skewness ( tail risk ) of the S&P 5 using a portfolio of SPX options Like the VIX Index, uses 3-day options and range of strikes can vary A statistical measure of expected probability distribution of SPX Statistic converted to index: SKEW = 1 1 * price of skewness Strike Skew compares the relative volatilities of OTM puts and calls equally spaced around ATM strike price (e.g., 9%-11% ) Most common reference for skew Flexible & intuitive CS Fear Barometer ( CSFB ) measures amount of downside put protection that can be purchased with the sale of a 1% OTM call Standardized pricing of a 3M zero-cost collar High level of CSFB means that investors are willing to sacrifice upside in order to buy downside protection 15

9% - 11% IV 9% - 11% IV is most common Skew reference 3 9%-11% Skew reflects different exposures depending on option maturity and prevailing volatility Delta skew (typically using 25-delta puts and calls) is a variation of strike skew that adjusts for volatility Variability of 9%-11% 3M IV less than 9%-11% 1M IV Term Structure of 9%-11% IV 25 15 1 5 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Source: Bloomberg 9%-11% 1M IV 9%-11% 3M IV 16

9-11 IV Difference SKEW 9% - 11% IV SKEW Index measures expected tail risk of SPX SKEW methodology reflects expected probability of outlier returns moves of 2 or more standard deviations 9-11 IV measures the relative cost of hedging with SPX collars Both influenced by changes in expected volatility, but not correlated Comparing SKEW Index & 9-11 SPX Implied Volatility 3 17 3 25 15 1 5 R² =.118 1 11 1 13 14 15 16 17 SKEW 16 15 14 13 1 11 1 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 SKEW 9%-11% 1M IV 25 15 1 5 Source: Cboe, Bloomberg 17

What the SKEW Index is saying about perceived tail risk SKEW Index based on SPX option quotes that have a non-zero bid Structural issues may be influencing SKEW levels: Minimum tick size $.5 Supply of out-of-the-money ( OTM ) options limited by high cost of capital and risk management practices; few traders can sell uncovered OTM puts; liquidity providers subject to Dodd-Frank capital charges; demand more edge Average Annual SKEW & VIX Index Levels 14 35 135 SKEW 135 VIX 13 3 125 25 1 115 15 11 15 1 1 5 199 1993 1996 1999 2 5 8 11 14 17 January 199 through August 18 Source: Cboe SKEW 2 SD Move Prob. 3 SD Move Prob. 1 2.3%.15% 15 3.65%.45% 11 5.%.74% 115 6.35% 1.4% 1 7.7% 1.33% 125 9.5% 1.63% 13 1.4% 1.92% 135 11.75% 2.22% 14 13.1% 2.51% 145 14.45% 2.81% 15 15.7% 3.1% 155 17.5% 3.4% 18

VIX / SPX ATM IV VIX / SPX ATM IV SKEW Is SKEW Index Tradable? VIX Index is calculated using prices of OTM SPX puts and calls, which reflect the expected left-leaning skewness of the S&P 5 Index Expect VIX values to reflect a premium over SPX ATM implied volatility; premium should correlate with SKEW, and suggests a way to trade SKEW 1.6 SKEW VIX / 1M ATM Imp. Vol. 1.4 1.2 1 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 17 16 15 14 13 1 11 1 1.5 R² =.6231 1.4 1.3 1.2 1.1 SKEW 1. 1 11 1 13 14 15 16 17 Source: Cboe, Bloomberg January 6 through August 18 19

Synthesizing Russell Option Skew 1.4 Can create proxy for Russell SKEW with RVX and Russell Index (RUT) 1-month at-the-money implied volatility RUT option skew has trended higher since 12, which reflect the expected leftleaning skewness of the Russell Index; not as steep as SPX skewness 1.3 1.2 1.1 1 1.6 1.5 1.4 1.3 1.2 1.1 RVX / RUT 1M ATM IV RVX / RUT 1M ATM IV D MA 1 1/4/1 1/4/11 1/4/12 1/4/13 1/4/14 1/4/15 1/4/16 1/4/17 1/4/18 Source: Cboe, Bloomberg VIX / SPX 1M ATM IV VIX / SPX 1M ATM IV D MA January 1 through August 18

VIX CSFB VIX 9% - 11% IV VIX SKEW Skew measures didn t foresee Feb correction 38 28 VIX SKEW 18 16 14 18 1 8 38 28 VIX 9%-11% 1 3 18 1 8 38 VIX CSFB 5 28 4 18 3 8 Source: Cboe, Bloomberg January 17 through August 18 21

SPX Implied Volatility due to demand for OTM calls Smirk became more of a smile Q3/Q4 17, January 18 as market moved to record highs; call selling slowed, short covering Skew indicators interpreted the inversion of ATM and OTM call IV as more balanced risk, lower skew Recent demand for OTM SPX calls driving SKEW lower 5 4 SPX Option Implied Volatility by Moneyness 3 1 Jan-16 Apr-16 Jul-16 Oct-16 Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Source: Cboe, Bloomberg 9% 1% 11% January 16 through August 18 22

VIX, VVIX & SKEW Term Structure

Roll-Down Premium VIX VIX What drives VIX futures term structure behavior? Mean reversion and long-term uncertainty drives VIX futures term structure. When VIX spikes, shorter dated futures are more responsive because less time for VIX Index to mean revert. Roll-Down premium (difference between front, second VIX futures prices) greatest in contango 1.9.8.7.6.5.4.3.2.1 4 3 2 1-1 -2-3 -4 Backwardation Contango Flat VIX Index Avg. Monthly "Roll-Down" Premium Avg. 1M VIX Level 5 45 4 35 3 25 15 1 5 4 35 3 25 15 1 5 Source: Cboe 24

VIX futures, SPX implied volatility term structures are related 1Y-1M Premium 1 1 1 11 11 12 12 13 13 13 14 14 15 15 15 16 16 17 17 18 18 VIX Constant maturity measures of SPX implied volatility: VIX3M (3-month) VIX6M (6-month) VIX1Y (1-year) Difference of 1-month SPX implied vol (VIX) and 1-year SPX implied vol (VIX1Y) simple way to measure term structure Structural difference between SPX IV, VIX futures term structure SPX Implied Volatility Term Structure 6 5 4 3 1 1 11 12 13 14 15 16 17 18 VIX Index VIX3M Index VIX6M Index VIX1Y Index Difference of VIX1Y & VIX 15 4 1 3 5-5 1-1 Source: Cboe VIX1Y - VIX D MA VIX D MA 25

VVIX Term Structure in backwardation, important implication for VIX options traders VVIX Term Structure January 2, 18 through January 31, 18 5-8 8-11 11-14 14-17 17-17 Source: Cboe 14 1/31/18 11 1/25/18 8 1/19/18 1/12/18 5 1/8/18 VV1 VV3 VV5 VV7 VV9 1/2/18 26

SKEW Term Structure generally upward-sloping but still reflects market shocks SKEW Term Structure January 16, 18 through February 15, 18 11-1 1-13 13-14 14-15 15 14 Source: Cboe 13 1 1/26/18 11 SK1 SK3 SK5 SK7 SK9 SK11 1/22/18 1/16/18 2/1/18 2/13/18 2/7/18 27

Correlation / Dispersion

VRP Volatility VRP Volatility Drivers of Correlation SPX volatility risk premium ( VRP ) defined as the difference between expected and realized volatilities Index option expected volatility driven by 2 factors: Volatility of index components How price moves of index components are correlated Comparing expected volatility of index options with expected volatility of options on index components extracts expected correlation Historically, SPX VRP has been positive on average; volatility sellers exposed to 2 risks stock volatility & correlation SPX Volatility Risk Premium 25 15 5-5 -15-25 -35-45 Stock Basket Volatility Risk Premium 25 15 5-5 -15-25 -35-45 Vol Premium VIX Realized Vol Stock Basket Vol Premium Stock Basket Expected Vol Stock Realized Vol 1 9 8 7 6 5 4 3 1 1 1 8 6 4 29

CRP VIX Defining & Capturing Correlation Risk Premium Implied correlation drawn to actual, realized correlation; 17 realized correlation especially in Q4 at historically low levels, which contributed to low VIX levels Historically, there has been a premium of implied to realized correlation; motivation for dispersion trades (selling index variance/buying basket of stock variance) 1.4 1.2 1.8.6.4.2 Correlation Risk Premium 1M Implied Correlation 1M Realized Correlation 2 1 1.5 1.5 Correlation Risk Premium VIX 8 6 4 -.5-1 7 8 9 1 11 12 13 14 15 16 17 18 3

What are ICJ, JCJ & KCJ? The Cboe S&P 5 Implied Correlation Indexes (ICJ, KCJ, JCJ) measure changes in the relative premium between index options and single-stock options. Index volatility is driven by a combination of two factors: the volatilities of index components and the correlation of index component price returns. ICJ, JCJ & KCJ are rotating tranches of implied correlation, each running for overlapping 2-year periods. Two tranches are active at any one time ICJ, JCJ & KCJ measure average implied correlation using SPX options and a tracking basket of the top 5 SPX components by market cap. Option implied volatilities are based on ATM strangles for both SPX options and options on stocks in the tracking basket. SPX tracking basket is re-balanced once per month 31

ICJ, JCJ, KCJ VIX ICJ, KCJ, JCJ VIX Correlation key driver of volatility - Tale of Two Correlation Regimes Implied correlation ranged from 5 7 through 15; began to decline in 16, along with the VIX Index After the 16 election, ICJ, JCJ & KCJ fell to historic lows, averaging 43. KCJ 18 fell below in October 17, as 1M realized correlation fell below 1. 8 6 7 6 5 5 4 4 3 3 1 1 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 (KCJ) JANUARY 18 (ICJ) JANUARY 16 (JCJ) JANUARY 17 VIX 8 7 4 6 5 3 4 3 1 1 Nov-16 Mar-17 Jul-17 Nov-17 Mar-18 Jul-18 (KCJ) JANUARY 18 (ICJ) JANUARY 19 (JCJ) JANUARY VIX Source: Cboe 32

Questions?

Disclaimer 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 or from The Options Clearing Corporation at www.theocc.com. Futures trading is not suitable for all investors, and involves the risk of loss. The risk of loss in futures can be substantial. You should, therefore, carefully consider whether such trading is suitable for you in light of your circumstances and financial resources. For additional information regarding futures trading risks, see the Risk Disclosure Statement set forth in CFTC Regulation 1.55(b). The information in these materials are provided for general education and information purposes only. No statement within these materials should be construed as a recommendation to buy or sell a security or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in these materials is available by contacting Cboe at www.cboe.com/contact. Past performance is not indicative of future results. Parameters relating to past performance of strategies discussed are not capable of being duplicated. These materials contain index performance data based on back-testing, i.e., calculations of how the index might have performed prior to launch. Back-tested performance information is purely hypothetical and is provided in these materials solely for informational purposes. Back-tested performance does not represent actual performance and should not be interpreted as an indication of actual performance. Index performance returns do not reflect management fees, transactions costs or expenses. No representation is being made that any investment will or is likely to achieve a performance record similar to that shown. Cboe, VIX, and Cboe Volatility Index are U.S. registered trademarks and Cboe Global Markets SM, SPX SM, SKEW SM, VVIX SM, and RVX SM are service marks of Cboe Exchange, Inc. S&P 5 is a trademark of Standard & Poor's Financial Services, LLC. Any products that have the an S&P Index or Indexes as their underlying interest are not sponsored, endorsed, sold or promoted by S&P or Cboe and neither Standard & Poor's nor Cboe make any representations or recommendations concerning the advisability of investing in products that have S&P indexes as their underlying interests. Russell is a registered trademark of the Frank Russell Company, used under license. All other trademarks and service marks are the property of their respective owners. 18 Cboe Exchange, Inc. All Rights Reserved. 34

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