Short Volatility Trading with Volatility Derivatives Russell Rhoads, CFA
Disclosure 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 future 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. 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. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor as to how taxes affect the outcome of contemplated options transactions. Cboe, Cboe Volatility Index, and VIX are registered trademarks, and Cboe Global Markets SM is a service mark of Cboe Exchange, Inc. S&P 500 is a registered trademark of Standard and Poor's Financial Services, LLC, used under license. Financial products based on S&P indices are not sponsored, endorsed, sold or promoted by Standard & Poor s, and neither Standard &Poor s nor Cboe make any representation regarding the advisability of investing in such products. All other trademarks and service marks are the property of their respective owners. 2018 Cboe Exchange, Inc. All Rights Reserved. 2
Short Volatility Trading Cboe Volatility Index Primer VIX Futures VIX Options Summary / Contact 3
Cboe Volatility Index The Cboe Volatility Index or the VIX Index 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 the VIX Index has displayed an inverse relationship with the S&P 500 which resulted in it being referred to as the fear index 4
Cboe Volatility Index 2700 VIX vs. S&P 500 Daily 2017 29 2600 2500 S&P 500 26 23 2400 20 2300 2200 VIX 17 14 2100 11 2000 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 8 Data Sources: Cboe Global Markets and Bloomberg 5
Cboe Volatility Index VIX vs. SPX January 2018 2900 20 2850 2800 S&P 500 18 16 2750 14 2700 VIX 12 2650 10 2600 1/2/18 1/4/18 1/8/18 1/10/18 1/12/18 1/17/18 1/19/18 1/23/18 1/25/18 1/29/18 1/31/18 8 Data Sources: Cboe Global Markets and Bloomberg 6
Cboe Volatility Index VIX vs. SPX 2018 January and February 2018 2900 38 2800 32 S&P 500 2700 26 2600 VIX 20 2500 14 2400 8 1/2/18 1/5/18 1/10/18 1/16/18 1/19/18 1/24/18 1/29/18 2/1/18 2/6/18 2/9/18 2/14/18 2/20/18 2/23/18 2/28/18 Data Sources: Cboe Global Markets and Bloomberg 7
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 8
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 9
VIX Futures Contango / Backwardation VIX Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9 10
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 Data Source: Cboe Global Markets 11
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 Data Source: www.cboe.com 12
Trades into Expiration Trading Example August 14, 2014 VIX @ 12.42 Sell 1 August VIX @ 12.95 August 19, 2014 VIX @ 12.21 Buy 1 August VIX @ 12.20 Profit = 0.75 13
Trades into Expiration Trading Example August 14, 2014 VIX @ 12.42 Sell 1 August VIX @ 12.95 Buy 1 September VIX @ 13.90 August 19, 2014 Buy 1 August VIX @ 12.20 (+0.75) Sell 1 September VIX @ 13.50 (-0.40) Profit = +0.35 14
Trades into Expiration Trading Example January 10, 2018 VIX @ 9.82 Sell 1 January VIX @ 10.55 January 16, 2018 VIX @ 11.66 Buy 1 January VIX @ 11.75 Loss = -1.20 15
Trades into Expiration Trading Example January 10, 2018 VIX @ 9.82 Sell 1 January VIX @ 10.55 Buy 1 February VIX @ 11.55 January 16, 2018 VIX @ 11.66 Buy 1 January VIX @ 11.75 Sell 1 February VIX @ 12.10 Loss = -0.65 16
VIX Options VIX Index options are cash settled contracts that share an expiration date with a VIX Future Traders are better served using VIX Futures as the best underlying pricing vehicle for valuing VIX Options This means that VIX Option positions are best priced off futures but settle in the spot index The multiplier for VIX Options is $100 and trading is available during both European and US market hours 17
VIX Options Friday August 12, 2016 VIX at 11.50 / Sep VIX Futures at 15.00 Call Bid Call Ask Strike Put Bid Put Ask 4.80 5.10 10 0.00 0.05 3.90 4.10 11 0.00 0.05 3.10 3.30 12 0.15 0.20 2.40 2.55 13 0.45 0.55 1.90 2.05 14 1.00 1.05 1.55 1.65 15 1.60 1.70 1.35 1.45 16 2.35 2.45 1.10 1.25 17 3.10 3.30 18
VIX Options VIX at 11.50 / September VIX at 15.00 Believe VIX Will Remain Low Considering Buying a VIX Put Put Strike Ask Price Break Even P/L VIX @ 11.50 12 0.20 11.80 0.30 13 0.55 12.45 0.95 14 1.05 12.95 1.45 15 1.70 13.30 1.80 16 2.45 13.55 2.05 17 3.30 13.70 2.20 19
VIX Options Buy 1 VIX Sep 14 Put at 1.05 4.00 3.00 2.00 VIX @ 11.50 VXU6 @ 15.00 1.00 0.00 11 12 13 14 15 16 17 18 19-1.00-2.00 20
VIX Options Bear Call Spread #1 March 23, 2016 VIX @ 14.75 May VIX @ 19.05 Sell 1 May VIX 25 Call at 1.25 Buy 1 VIX May 28 Call at 0.85 Net Credit = 0.40 21
VIX Options 2.00 Bear Call Spread #1 1.00 VIX @ 14.75 VXK6 @ 19.05 0.00 16 19 22 25 28-1.00-2.00-3.00 22
VIX Options Bear Call Spread #2 March 23, 2016 VIX @ 14.75 May VIX @ 19.05 Sell 1 May VIX 22 Call at 1.70 Buy 1 VIX May 30 Call at 0.70 Net Credit = 1.00 23
VIX Options 6.00 Bear Call Spread #2 3.00 VIX @ 14.75 VXK6 @ 19.05 0.00 14 16 18 20 22 24 26 28 30 32-3.00-6.00-9.00 24
Short Volatility Trading Both VIX futures and options offer opportunities to short market volatility Recent market action reminds us to have risk controls in place when taking a short volatility position 25
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 26