Interactive Brokers Webcast Methods for Getting Long Volatility September 17, 2014 Presented by Russell Rhoads, CFA Copyright 2014 CBOE
Disclosure Statement 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, by calling 1-888-OPTIONS, or from The Options Clearing Corporation at www.theocc.com. Futures trading is not suitable for all investors and involves risk of loss. 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 future or to provide investment advice. Any strategies discussed, including examples using actual securities or futures price data, are strictly for illustrative and educational purposes only. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all transactions and must be considered prior to entering into any transactions. Multiple leg strategies involve multiple commission charges. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Past performance does not guarantee future results. Supporting documentation for any claims, comparisons, statistics or other technical data in this presentation is available from CBOE upon request. The CBOE Volatility Index (VIX index) methodology is the property of Chicago Board Options Exchange, Incorporated (CBOE). CBOE, Chicago Board Options Exchange, CBOE Volatility Index, Execute Success and VIX are registered trademarks and The Options Institute is a service mark of CBOE. S&P 500 is a registered trademark of Standard & Poor's Financial Services, LLC and has been licensed for use by CBOE and CBOE Futures Exchange, LLC (CFE). Financial products based on S&P indices are not sponsored, endorsed, sold or promoted by S&P and S&P makes no representation regarding the advisability of investing in such products. CBOE is not affiliated with Interactive Brokers. 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 2014 CBOE. All rights reserved. The Options Institute at CBOE 2
Methods for Getting Long Volatility Outline Volatility Index Review VIX Index Price Behavior Review of VIX Options Trading Examples Resources The Options Institute at CBOE 3
Volatility Index Review Review A volatility index such as VIX is a consistent measure of implied volatility as indicated by option pricing VIX is a consistent 30 day measure of implied volatility based on S&P 500 Index option pricing Volatility indexes that are based on broad based equity market option trading have consistently exhibited an inverse relationship with the underlying market The Options Institute at CBOE 4
VIX Price Behavior CBOE Volatility Index vs. S&P 500 January 2, 2014 August 15, 2014 2000 40 1900 35 1800 S&P 500 30 25 1700 VIX 20 1600 15 1500 10 1/2/14 2/10/14 3/19/14 4/25/14 6/3/14 7/10/14 8/15/14 Data Source: Bloomberg The Options Institute at CBOE 5
VIX Price Behavior Mean Reversion VIX vs. 10 Day Average January 1, 2014 August 15, 2014 22 20 18 10 Day Moving Average 16 VIX 14 12 10 1/2/2014 2/10/2014 3/19/2014 4/25/2014 6/3/2014 7/10/2014 8/15/2014 Data Source: Bloomberg The Options Institute at CBOE 6
VIX Price Behavior VIX Daily Changes by Percent January 2, 2007 August 15, 2014 175 150 125 100 75 VIX Rose 10% or more 188 of 1919 trading days 50 25 0-65 -60-55 -50-45 -40-35 -30-25 -20-15 -10-5 0 5 10 15 20 25 30 35 40 45 50 55 60 65 Data Source: Bloomberg The Options Institute at CBOE 7
VIX Price Behavior Is VIX Low? Historical Perspective on Average VIX 45 40 35 1 Year 30 25 20 15 10 Year 5 Year 10 5 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Data Source: Bloomberg The Options Institute at CBOE 8
Behavior of Volatility Mean Reversion Implied volatility is a range bound measure At times there may be some extreme moves But generally implied volatility oscillates around a mean In time Historically a move up in VIX is usually followed by a drop In the past, periods of complacency in VIX have tended to be followed by a spike The Options Institute at CBOE 9
VIX Option Pricing Overview VIX Option Pricing Example VIX at 10.90 VIX Aug 15 Put @ 2.40 15.00 2.40 = 12.60 Aug VIX Futures @ 13.60 Best underlying pricing vehicle for VIX options is the corresponding VIX futures contract The Options Institute at CBOE 10
VIX Option Pricing Overview VIX Call Option Pricing Example VIX at 10.90 VIX Aug 15 Call @ 1.05 Aug VIX Futures @ 13.60 Break-even buying the 15 Call is 16.05 The Options Institute at CBOE 11
Trading Examples Long Call 13 Trading Days to June Expiration VIX at 11.55 June VIX Futures at 13.25 Buy 1 VIX Jun 16 Call @ 0.35 The Options Institute at CBOE 12
Trading Examples Long Call Payoff Diagram 7.50 5.00 2.50 VIX @ 11.55 VXM4 @ 13.25 0.00 12.00 14.00 16.00 18.00 20.00-2.50 The Options Institute at CBOE 13
Trading Examples Long Call Spread 14 Trading Days to June Expiration VIX at 11.70 June VIX Futures at 13.45 Buy 1 VIX Jun 19 Call @ 0.50 Sell 1 VIX Jun 20 Call @ 0.40 Net Cost = 0.10 The Options Institute at CBOE 14
Trading Examples Long Call Spread Payoff Diagram 1.50 1.00 0.50 VIX @ 11.70 VXM4 @ 13.45 0.00 12.00 14.00 16.00 18.00 20.00 22.00-0.50 The Options Institute at CBOE 15
Trading Examples Employment Number Trade 8 Trading Days to February Expiration VIX at 12.90 Feb VIX Futures at 14.55 Sell 1 VIX Feb 13 Put @ 0.30 Buy 1 VIX Jun 16 Call @ 0.50 Sell 1 VIX Jun 20 Call @ 0.05 Net Cost = 0.15 *VIX Feb 10 Put was offered at 0.05 The Options Institute at CBOE 16
Trading Examples Employment Number Trade Payoff Diagram 5.00 4.00 3.00 2.00 1.00 VIX @ 12.90 VXG4 @ 14.55 0.00 11.00 12.00 13.00 14.00 15.00 16.00 17.00 18.00 19.00 20.00 21.00-1.00-2.00-3.00-4.00 The Options Institute at CBOE 17
Trading Examples Short Straddle + Long Call 21 Trading Day to March Expiration VIX at 13.60 March VIX Futures at 14.70 Sell 1 VIX Mar 17 Call @ 0.95 Sell 1 VIX Mar 17 Put @ 2.70 Buy 1 VIX Mar 19 Call @ 0.55 Net Credit = 3.10 The Options Institute at CBOE 18
Trading Examples Short Straddle + Long Call Short VIX Mar 17 Straddle + Long VIX Mar 19 Call 4.00 3.00 VIX @ 13.60 2.00 1.00 0.00-1.00-2.00 12.00 14.00 16.00 18.00 20.00 22.00 Mar VIX @ 14.70-3.00-4.00-5.00 The Options Institute at CBOE 19
Trading Examples Summary Typically VIX futures are priced at a premium relative to the underlying index This results in VIX call options appearing very expensive when considering the level of the spot index Spread trades have become more common where traders are getting upside exposure to VIX at a low cost The Options Institute at CBOE 20
Getting Long Volatility Resources CBOE Volatility Indexes Home Page www.cboe.com/volatility CBOE Futures Exchange www.cfe.cboe.com CBOE Blog Site www.cboeoptionshub.com Russell Rhoads, CFA rhoads@cboe.com Twitter @russellrhoads The Options Institute at CBOE 21