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March 2012 | Vol. 3 No

MONTHLYT H E O P T I O N T R A D E R S J O U R N A L

2012 Volatility

Forecast for the

S&P 500

An Interview with

Mark Longo

The VIX Term Structure as a

Predictor of Future Returns



www.expiringmonthly.com March 2012 2

ONTHLYT H E O P T I O N T R A D E R S J O U R N A L

editorial

Bill Luby Jed Woodd

Mk Sebstin

andew Giovinzzi

design/layout

Luen Woodow

contact information

Editoil omments: [email protected]

advetising nd Sles

Expiing Montly PesidentMk Sebstin: [email protected]

Pone: 773.661.6620

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publition does not mke pesonlized eommendtions. Tis info-

mtion sould not be onstued s n oe to sell o soliittion to

buy ny seuity. Te investment sttegies o te seuities my not

be suitble fo you. We believe te infomtion povided is elible;

oweve, Expiing Montly nd its lited pesonnel do not gu-

ntee its uy, timeliness, o ompleteness. any nd ll opinionsexpessed in tis publition e subjet to nge witout notie. In

espet to te ompnies o seuities oveed in tese mteils, te

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mendtions (if mde) o views ontined in tis publition. Expiing

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tions in te seuities efeened in tese mteils.

Options tnstions involve omplex tx onsidetions tt sould

be efully eviewed pio to enteing into ny tnstion. Te isk of

loss in tding seuities, options, futues, nd foex n be substntil.

customes must onside ll elevnt isk ftos, inluding tei own

pesonl nnil sitution, befoe tding. Options involve isk nde not suitble fo ll investos. See te options dislosue dou-

ment cteistis nd risks of Stnddized Options. a opy n

be downloded t ttp://www.optionsleing.om/bout/publitions/

te-isks.jsp.

Expiing Montly does not ssume ny libility fo ny tion tken

bsed on infomtion o dvetisements pesented in tis publition.

No pt of tis mteil is to be epodued o distibuted to otes by

ny mens witout pio witten pemission of Expiing Montly o its f-

lites. Potoopying, inluding tnsmission by fsimile o emil sn,

is poibited nd subjet to libility. copyigt © 2012, Expiing Montly.

contents

4 e’ n

Bill Luby

5 a x

The Expiring Monthly Editors

7 2012 V f

s&p 500

Jared Woodard

9 t Vix t s p

f r

Bill Luby

12 h Vix

Mark Sebastian

14 t m h--B

Andrew Giovinazzi

16 expiring monthly feature

w Vix o r p

Reed Hogan, Guest Contributor

22 e m iv

m l

Mark Sebastian

24 floor stories: s d

Andrew Giovinazzi

25 follow that trade: t av

a Newsletter

Mark Sebastian

27 back page: f t v. f f

Bill Luby

mailto:editor%40expiringmonthly.com?subject=

mailto:marks%40expiringmonthly.com?subject=

http://www.optionsclearing.com/about/publications/character-risks.jsp




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About the

Expiring Monthly Team

Bill Luby

Bill is pivte investo wose ese

nd tding inteests fous on voltility,

mket sentiment, tenil nlysis,

nd ETFs. his wok s been s been

quoted in te Wll Steet Jounl,

Finnil Times, Bon’s nd ote

publitions. a ontibuto to Bon’s

nd Minynville, Bill lso utos te VIX

nd Moe blog nd n investment

newslette fom just not of Sn

Fniso. he s been tding options sine 1998.

Pio to beoming full-time investo, Bill ws business stt-

egy onsultnt fo two dedes nd dvised lients oss

bod nge of industies on issues su s sttegy fomul-

tion, sttegy implementtion, nd metis. Wen not tding o

blogging, e n often be found unning, iking, nd kyking

in Noten clifoni.

Bill s Ba fom Stnfod Univesity nd n MBa fom

cnegie-Mellon Univesity.

Jared Woodard Jed is te pinipl of condo

Options. Wit ove dede of

expeiene tding options, equities,

nd futues, e publises te condo

Options newslette (ion ondos) nd

ssoited blog.

Jed s been quoted in vious

medi outlets inluding Te Wll

Steet Jounl, Bloombeg, Finnil

Times alpville, nd Te cigo Sun-Times. he is lso on-

tibuto to TeSteet’s Options Pots sevie.

In 2008, e ws poled s top options mento in Stoks,

Futues, nd Options Mgzine. he is lso n ssoite membe

of te Ntionl Futues assoition nd egisteed pinipl of

clinmen Finnil Goup LLc, ommodity tding dviso.

Jed s mste’s degees fom Fodm Univesity nd te

Univesity of Edinbug.

Mark Sebastian

Mk is pofessionl option tde

nd option mento. he gduted

fom Villnov Univesity in 2001 wit

degee in nne. he ws ied into

n option tde tining pogm by

Goup 1 Tding. he spent two yes

in New Yok tding options on te

amein Stok Exnge befoe

moving bk to cigo to tde SPX

nd DJX options Fo te next ve

yes, e tded viety of option poduts suessfully, bot

on nd o te cBOE oo.

In Deembe 2008 e stted woking s mento t Seidn

Option Mentoing. cuently, Mk wites dily blog on ll

tings option tding t Option911.om nd woks pt time

s isk mnge fo edge fund. In M 2010 e beme

Dieto of Edution fo new edution m OptionPit.om.

AndrewGiovinazzi andew Giovinzzi stted is ee in

te nnil mkets fte gduting

fom te Univesity of clifoni, Snt

cuz wit B.a. in Eonomis in 1989.

he joined Goup One, Ltd. nd quikly

beme membe of te Pi Stok

Exnge (nd lte te cBOE), wee

e tded bot equity nd index

options ove 15 ye spn. Duing

tt peiod e neve d down ye.

at te sme time, andew stted nd n te Designted

Pimy Mket Mke post fo GoupOne on te oo of te

cBOE. It beme one of te igest-gossing posts fo te

ompny in 1992 nd 1993. Wile tively tding, andew ws

instumentl in eting nd mnging n option tde tin-

ing pogm fo Goup One.

he left Goup One, Ltd. to o-found heny cpitl Mngement

in 2001. andew ten joined aqumin LLc (2008–2011) to elp

bing 3D quoting nd nlysis to nnil dt. he is cief

Options Sttegist t Option Pit.




Editor’s

NotesBill Luby

as Expiring Monthly begins its tid ye, I m eminded

gin wy I enjoy tis publition. Wee else n I nd

note goup of mnis tt e enoug bout te VIX

nd voltility to nlyze it nd wite bout it on egul

bsis?

Tis mont is no exeption. Wit M losing in on te

eod fo te lgest VIX futues montly ontngo, inteest

in tis voltility mesue s spiked one gin. Fom tis

mont’s fetue tile to te ask te Xpets Q&a nd sev-

el tiles tt exmine itil spets of te VIX, we e

ll ove te subjet of voltility one gin.

Guest ontibuto reed hogn is esponsible fo tis

mont’s fetue tile, Why VIX Options Are Richly Priced.

Tis tile tkes n in-dept look t te vine isk pe-

mium in VIX options nd s impotnt implitions fo td-

ing options in n envionment like te uent one wee te

VIX tem stutue is in steep ontngo.

In two elted tiles, Jed Woodd disusses te

disepnies between vious ppoes to foesting

voltility fo te S&P 500 index fo 2012 nd I exmine te

istoy of te VIX futues tem stutue nd its usefulness

fo pediting futue etuns in te SPX nd te VIX.

Mk Sebstin lso tkles te VIX, looking t its full

istoy nd explining longe-tem VIX yles in tems of key

tlysts nd men evesion.

In tis mont’s fetue inteview, Mk tlks wit Mk

Longo of TeOptionsInside.om bout te evolution of te

vious options exnges nd ow intenet-bsed options

ontent is nging.

andew Giovinzzi delves into d-to-boow stoks

nd some of te implitions tis sitution s fo options

tdes.

andew lso eminises bout voltility spike in

MNuggets t te cBOE.

In tis mont’s Follow Tt Tde olumn, Mk Sebstin

etuns to exmine te impt of newslette eommend-

tion on option pies nd disusses ow to pot fom it by

plying te voltility ngle wit n djent stike.

One gin, te EM tem is bk to nswe ede ques-

tions in te ask te Xpets segment nd I etun to te Bk

Pge to ttempt to tie togete te cold W, libety nd isk

as lwys, edes e enouged to send questions,

omments o guest tile ontibution ides to edito@

expiingmontly.om.

hve good expition yle,

Bill Luby

Contributing Editor








Q: I see that the CBOE has

just started publishing a

“VIX of VIX” index. On the

surface this seems like

another product of ques-

tionable value and I don’t

really understand how this

is going to work with the

underlying.

A: On M 14, te cBOE

begn publising vlues

fo tei new “VIX of VIX”

index unde te tike

symbol VVIX. Te ide of

te voltility of voltility

migt sound stnge, but I

tink tis index will tully

pove vey useful to tdes

nd investos like.

VVIX povides om-

peensive estimte of te

implied voltility of VIX

options. Wt te VIX is

to SPX, VVIX is to VIX: so

nyone wo tinks VIX is

useful estimte of SPX

implied voltility sould

tink tt VVIX will pob-

bly be useful estimte

of ow i o ep VIX

options e s well. VIX

options ve beome

inesingly popul in

eent yes s dily

volume nd open inte-

est ontinues to mk

new igs. If you ve

eve tded VIX option

ontt, you pobbly

wnted to know wt te

implied voltility of te

option ws, nd wete

it ws i o ep

omped to te eent

istoil voltility of te

fowd VIX vlue tt

undelies te options. VVIX

povides quik, ig-level

estimte of te level t

wi VIX options e being

pied.

as noted t te VVIX

Wite Ppe link, one of te

pinipl pplitions of

VVIX estimtes will be by

tdes seeking to ptue

te voltility isk pemium

in VIX options, topi I ve

witten bout osion-lly nd te topi of reed

hogn’s fetue tile in

tis mont’s issue. It is

fily well-known tt SPX

option pemiums tend to

be ige, on vege, tn

is wnted by te tul

voltility exibited by te

undelying index. Tt’s ll

te pse “voltility isk

pemium” elly mens.

Wt VVIX will mke plin

to moe tdes is tt VIX

options e, on vege,

lso ily pied.

—Jed

Q: I am a part time options

trader, new(er) to the VIX.

I’m looking at a calendar spread which looks good,

but makes me nervous

because of the unknown

factor. I’m wondering if the

near term IV can spike much

higher than the longer term

IV options, thus turning

what looks like a good trade

into a nightmare. I don’t

know where to nd the his-

torical data on such a trade,

so I appeal to your personal

knowledge instead. If you

have a moment, I’d love to

know your thoughts on this

type of setup. Trying to g-

ure out what my risks are.

—Chris C.

A: Te inteesting ting

bout VIX options is tt

you sould not tink bout

tem ll being bsed on te

sme undelying. Te best

ppoximtion fo e

VIX option is te VIX futue

of te sme mont, so

igt now wit te VIX

M futues t 20.15,

te apil futues t 23.35,

te My futues t 25.10,

et. tese e not pples

to pples ompisons s

tee e distintly die-

ent undelying seuities

fo e. Fo tis eson,

you sould lso tink of

My 25 ll s being “in te

money” even wit VIX of

17.34 s I type tis. Tink

fo moment tt te VIX

ould go up lmost 50%

to 24.99 nd te My 25s

would still expie wot-

less, beuse te mket is

ntiipting n even lge

move.

all tis is ontext fo

you question.

Te big poblem is tt

if you e sot My nd

long aug VIX options nd

te VIX spikes in My, te

aug options e likely to

move vey little eltive

to te My, beuse tey

e ntiipting signi-

nt men evesion tee

monts lte.

Ask the

perts The Expiring Monthly Editors

Te ide of

te voltility of

voltility migt

sound stnge,

but I tink

tis indexwill tullypove veyuseful to

tdes nd

investos like.

http://www.cboe.com/micro/VVIX/VVIXwhitepaper.aspx







Don’t be supised, fo

instne, if fo evey 10

points ige te VIX My

futues move in My, te

aug futues move only

3 points. So . . . I don’t tink

you biggest issue is font

mont IV so mu s te

ft tt te aug ‘edge’

is elly just smll f-

tion of wt you pobbly

tink it is. Tis gpi of

te Febuy 27, 2007 VIX

spike sould illustte n

exteme exmple some of

wt I m tlking bout.

Fo wt it is wot, just

bout eveyone wo tdes

VIX options ends up looking

t tde just like te one

you pesented me. Tis

would tully be good

one to wt nd see wt

ppens, but if I wee you

I would pobbly sty wy

fom VIX lend tdes

(o devote vey smll

mount of money to wtI ll poof-of-onept

tde expeiment) until I

got bette ndle on te

isks involved, s My

VIX spike ould be vey

expensive lesson.

—Bill

Q: I have calls in AAPL

stock, if it has a dividend

am I going to lose money

on my calls?

—Ralph

A: Te nswe is mybe.

Te wy te Occ ndles

dividends is dieent fo

speil dividends vs. egu-

l deled dividends. Fo

speil dividend, if it is

of ny substntive vlue

te options e going to

be djusted utomtilly.

Tis will not ve n eet

on you pot nd loss. If

aaPL deides to dele

egul dividend, te lls

you old fte te exdivi-

dend will lose vlue. Tis is

beuse of nge in te

ost of y funtion of put

ll pity. remembe: cll

less Put equls Seuity

less stike pie plus ost

of y. an inese in divis going to edue te ost

of y nd tus lowe te

vlue of lls.

hope tt elps,

—Mk

Ask the Xperts (continued)

Specializing in Trade Structure, Risk Management and Capital Efficiency

www.optionpit.com

For Information Call (888) TRADE-01

Visit Our Website

http://vixandmore.blogspot.com/2007/05/vix-futures-one-picture-to-remember.html

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2012 Volatility Forecast for the

S&P 500 Jared Woodard

as u.s. economic dt impove

nd it looks like te mket is in

denitive bullis mode, lot of inves-

tos e wondeing wt to tink bout

te eltively ig implied voltility in

options pies nd VIX futues. Do te

options mkets know someting tt

no one else does? ae ig pemiums

just n tift of te lst sevel yes

of voltile pies? To get le view of

voltility expettions, I looked t te

pies of sevel ssets ll tied to te

S&P 500.

Te tted t (Figue 1)

sows fou implied voltility estimtes

fo M 2012 toug Deembe

2013. Te seies displyed sow

estimtes bsed sttistil Garch

foest, te pies of t te money

SPX options, VIX-style

estimtes inopot-

ing most t- nd out of

te money SPX options,

nd VIX futues. I posted simil foe-

st t in Jnuy 2011 looking t

dt fom SPX options, VIX-style SPX

IV, VIX futues, SPX vine futues,

nd Garch estimte. (See ”2011

Voltility Foest fo te S&P 500”)

Sine ten, te cBOE s stopped

listing 12-mont S&P 500 vine

futues ontts, nd te 3-mont

swp futues e listed only fo June

nd Septembe 2011, so I eleted

not to inlude tem ee. In te t

posted lst ye, estimtes wee dis-

plyed on “dys fowd” bsis,

wi mde efeing to te t

less intuitive fte te ft; I ve

nged te x xis tis ye to eet

spei dtes.

regding te soues of tese

estimtes, you e etinly ledy

fmili wit SPX options nd VIX

futues. as befoe, te VIX futues

seies plotted ee sows vlues one

mont fte ontt expition, sine

te futues e estimtes of VIX vl-

ues t expition, nd VIX itself s

30-dy oizon. Some edes my

not know tt te cBOE publises VIX-

style estimtes fo SPX implied voltil-

ity t oizons ote tn te 30-dy

nd 90-dy peiods tked by VIX nd

VXV. (cBOE VIX Tem Stutue Dt)

Finlly, genelized utoegessive

onditionl eteoskedstiity (Garch

is popul sttistil model useful

fo mesuing time seies tt exibit

voltility lusteing.

Tese fowd-looking estimtes

sould be viewed in te ontext of

pio mket etuns. Sine 1950, te

vege one-ye istoil voltility

of te S&P 500 ws 14%; te nnul

vege ws 16.6% sine 1980. Sine

te ye 2000, te vege one mont

istoil voltility of te S&P 500

(obseved dily) s been 18.76%.

Wile it seems like te stok mket is

beoming moe voltile ove time, it is

wot noting tt te ses in 1980,

2000/1, nd 2008 likely ount fo

te uptik. Te uent one-mont SPXFigure 1 2012–2013 S&P 500 Volatility Forecast

c o n d o r O p t i o n s , c

B O E

http://www.expiringmonthly.com/2011-volatility-forecast-for-the-s-p-500.html


http://www.cboe.com/data/volatilityindexes/volatilityindexes.aspx

http://www.cboe.com/data/volatilityindexes/volatilityindexes.aspx






istoil voltility is just unde 10%.

Te ft tt te mket s tded

so quietly in eent monts eltive to

long-tem veges migt explin wy

te pies of options e so pesis-

tently ig in IV tems.

One dispity wot notiing is

between te estimtes of VIX-style SPX

option IV nd VIX futues. Fo exmple,

SPX options fo Septembe expition

e pied su tt, if we inopote

nd weigt ppopitely te voltil-

ity skew eeted in OTM options, we

get VIX-style Septembe estimte of

bout 24%. But VIX futues fo august

expition (estimting wee 30-dy

VIX estimte fo Septembe will be)

e pied t bout 26.5%. Tis el-

tionsip between VIX-style SPX IV esti-

mtes nd VIX futues in lst ye’s

suvey, too: VIX futues wee onsis-

tently pied ouple points bove

SPX estimtes. It s been vey popu-

l in eent monts to ttibute te

steep VIX futues uve to te inese

in volume in voltility ETPs like VXX

nd TVIX. I ve pesented evidene

in sevel posts on te condo Options

blog tt tee is no disenible

impt of te inesed populity of

voltility ETPs on SPX options pies,

OTc vine swp tes, o veg

notionl outstnding. Te ft tt

VIX futues nd SPX VIX-style IV

e in typil eltionsip po-

vides dditionl evidene of mket

nomly.

It is d to gue wit bot eli-

ble sttistil estimte povided by

te Garch model nd wit implied

voltility t te sme time. Unless

ll of tese models e wong, te

eminde of 2012 is likely to be moe

voltile tn te st qute s

been. EM

2012 Volatility Forecast for the S&P 500 (continued)

http://condoroptions.com/

http://www.condoroptions.com/

http://condoroptions.com/




The VIX Term Structure as a Predictor of

Future ReturnsBill Luby

this past month s seen te

lgest sustined cBOE Voltility Index

(VIX) futues ontngo in istoy nd

long wit tis penomenon s ome

ost of questions bout ow signi-

nt te VIX futues tem stutue

is in tems of pediting futue stok

mket etuns s well s pediting

futue voltility.

I toued on te subjet of te

peditive bility of te VIX futues

tem stutue in Otobe in Investing

Implications of the VIX Term Structure,

wen I exmined te futue etun

pttens of equities, bonds, gold nd

VIX-bsed exnge-tded poduts

in mkets teized by ontngo

nd bkwdtion of te VIX futues

tem stutue. Wile tis type of nl-

ysis my be elpful fo teizing

te mket fo VIX futues in genel

tems, s te VIX futues e in on-

tngo 75–80% of te time, degee

of dditionl speiity ould e-

tinly bette infom tding sttegies

tt ount fo te spe of te VIX

futues tem stutue s key input

into te sttegy poess.

as esult, tis time

ound I ve undetken

n nlysis tt is moe

gnul nd onsides

te degee of ontngo

nd bkwdtion in te

VIX futues nd ttempts

to detemine te eltion-

sip between te slope

of te VIX futues tem

stutue nd futue etuns in te S&P

500 index. Tee questions in ptiu-

l I oped to nd nswes to:

1. Is exteme ontngo useful fo

pediting te futue pefomne

of te SPX o te VIX?

2. Is exteme bkwdtion useful

fo pediting te futue pefo-

mne of te SPX o te VIX?

3. Is tee line eltionsip

between te slope of te VIX

futues tem stutue nd te

futue etuns of eite te SPX o

te VIX?

Analysis of VIX Futures Term

Structure by Decile

VIX futues dt e vilble going

bk to te M 2004 lun of te

VIX futues. Fo te st two yes VIX

futues ontts wee tded, te

ontt monts wee limited nd

somewt pzd. It ws not until

Otobe 2006 tt te cBOE evmped

te VIX futues ontts, dding

enoug monts to ensue tt te st

ve onseutive monts wee lwys

oeed. Sine My 2008, t lest te

st seven onseutive monts ve

been vilble to tde.

In evluting te VIX futues tem

stutue dt, I nlyzed te full set

of VIX futues settlement pies going

bk to 2004 s well s te moe mod-

en onseutive font ve monts dt

subset tt oigintes in Otobe 2006

In e se, I lulted te slope of

te VIX futues tem stutue fom

ll vilble VIX futues ontts fo

e dy, ten used te slope of te

ovell VIX futues tem stutue to

ete ten bukets of VIX futues dt.

Fo tese deiles, I ten lulted te

men etuns fo e deile fo bot

te SPX nd te VIX fo seven sep-

te peiods nging fom 1 dy to 100

dys. as noted elie, I pefomed te

sme nlysis fo te dt fom M

2004 nd te ontinuous onseutive

ontt dt fom Otobe 2006. as

it tuns out, tee wee only mino dif-

feenes between te dt fom M

2004 nd te dt fom Otobe 2006,

so I eleted to fous on te full dt

set fom M 2004.

an nlysis of te deile dt

sowed two pomising developments.

Fist, te top pefoming deile fo te

SPX fo peiods fom 1–100 dys ws

ovewelmingly te deile wit te

B A downward

sloping futures term structure inwhich the front months are more

expensive than the back months.

c An upward sloping

futures term structure in which

the front months are less expen-

sive than the back months.




most exteme VIX futues ontngo.

at te sme time, te wost pefom-

ing deile fo te VIX fo peiods

nging fom 1–100 dys ws ove-

welmingly te deile wit te most

exteme VIX futues bkwdtion.

Wile it ws inteesting to see

tt te two VIX futues tem stu-

tue extemes oinided wit te best

pefoming SPX dt nd te wost

pefoming VIX dt, wt ws just s

inteesting ws tt tese ppened

t te opposite ends of te VIX futues

tem stutue extemes. In ft, wile

exteme VIX futues bkwdtion

seemed to be n exellent pedi-

to of futue VIX delines, it ppeed

to ve vey little peditive vlue

in tems of futue SPX pefomne.

Similly, wile exteme ontngo

seemed to be n exellent pedito of

futue SPX gins, it ppeed to ve

only wek peditive vlue in tems

of futue VIX pefomne.

Given te iness of te esults fo

te SPX in steep ontngo nd te VIX

in exteme bkwdtion, te mount

of noise in te blne of te quintile

dt ws etinly disppointing.

Summarizing the Data by

Quintile

consideing te possibility tt te

deile dt migt be too gnul,

I ggegted te esults fom te ten

quintiles into ve deiles in ope tt

te lge bukets (n=201 fo te deile

bukets, n=402 fo te quintile bukets)

migt yield some moe distint pttens

oss te full set of quintiles.

Figue 1 summizes te quin-

tile dt fo futue etuns fo te SPX

using VIX futues dt fom M

2004 to te pesent, wit quintile 1

(slope of 0.0302) ggegting te dt

fo tt 20% of te time wen te VIX

futues wee in te steepest ontngo

nd quintile 5 eeting te 20% of te

time wen te VIX futues bkwd-

tion ws most ponouned.

Wit ny luk, te olo oding

mkes tis tble esie to ed. Note,

fo instne, tt te ontngo-evy

quintile 1 s eite te igest gge-

gte gins (bigt geen sding) o

seond igest ggegte gins (olive

geen sding) fo e peiod fom

1–100 dys into te futue. as ws te

se wit te deile nlysis, ow-

eve, te quintile summtion dt fo

exteme bkwdtion in quintile 5

sows tt wile exteme bkwd-

tion is ssoited wit te igest

gins on te next tding dy, looking

out 3–100 dys evels pefomne

dt tt is fo te most pt igt in

te middle of te ote deiles.

conveting te VIX pefomne

dt fom deiles to quintiles lso

yields little in te wy of dditionl

insigts. Figue 2 sows tt exteme

VIX futues bkwdtion (quintile 1) is

n exellent pedito of futue delines

in te VIX. On te ote nd, quin-

The VIX Term Structure as a Predictor of Future Returns (continued)

Figure 1 Mean SPX Performance by VIX Futures Slope Quintile

Figure 2 Mean VIX Performance by VIX Futures Slope Quintile

Te S&P 500 index is onsistent

outpefome wen te VIX futues

tem stutue is in steep bkwdtion.




tile 2, wile inludes dt fom peiods

in wi te VIX futues tem stutue

is eltively t, sows te VIX out-

pefoming te medin etun fo ll

quintiles oss ll time oizons. also,

wile te VIX does sow bove vege

gins wen te VIX futues tem stu-

tue is in ontngo (deile 1), tese

gins e diult to distinguis fom

tose in quintile 3 o quintile 4. In ft,

quintile 3, te middle quintile, sows

te best ggegte gins in te VIX fo

ll peiods toug ve dys—wi is

neve te sign of obust model.

Conclusion

Bsed on te deile nd quintile

nlysis summized bove, tee is

ompelling evidene tt te S&P 500

index is onsistent outpefome

wen te VIX futues tem stutue

is in steep bkwdtion. Similly,

te VIX onsistently undepefoms

wen te VIX tem stutue is in

bkwdtion.

Unfotuntely, te dt mke it

diult to extend te onlusions

bove even to te futue pefomne

of te SPX wen te VIX futues e

in exteme bkwdtion o te VIX

wen te futues e in exteme on-

tngo. retuning to te questions

posed t te beginning of tis tile,

te deile nd quintile dt e suf-

iently noisy tt I m pevented

fom estblising line eltionsip

between te slope of te VIX futues

tem stutue nd futue pefomne

of te SPX o te VIX t tis time.

Tt being sid, te peditive

vlue of te VIX futue tem stu-

tue t extemes s some inteesting

implitions fo tdes. Fo sttes,

s f s te futue SPX pefomne

is onened, exteme VIX futues

ontngo pesents some inteesting

oppotunities fo tdes wit bullis

dietionl bis nd suggests tt te

need fo potfolio potetion fo longs

is miniml in tis type of envionment.

Tuning to te pefomne of te

VIX, peps te key tkewy is tt

wile exteme VIX futues bkwd-

tion is ssoited wit subsequent

delines in te VIX due to men-eve-

sion, te degee of VIX futues ontngo

s little being on te futue pefo-

mne of te VIX index. Tis onlusion

sould be of get inteest fo tose

wo tde VIX futues, VIX options nd

VIX exnge-tded poduts. EM

f r

“Exploing te VIX Futues Tem Stutue,

Pt I,” Expiring Monthly, august 2010.

“an Intepetive Fmewok fo VIX

Futues (Seond in Seies),” Expiring

Monthly, Septembe 2010.

“VIX Futues: Putting Ides into ation

(Tid in Seies),” Expiring Monthly, Otobe 2010.

“a histoy of VIX Futues roll Yields,”

Expiring Monthly, Septembe 2011.

“Investing Implitions of te VIX Tem

Stutue,” Expiring Monthly, Otobe

2011.

“clulting te Futue rnge of te VIX,”

Expiring Monthly, Febuy 2012.

The VIX Term Structure as a Predictor of Future Returns (continued)

http://www.expiringmonthly.com/exploring-the-vix-futures-term-structure-part-1.html


http://www.expiringmonthly.com/an-interpretive-framework-for-vix-futures-second-in-a-series.html


http://www.expiringmonthly.com/vix-futures-putting-ideas-into-action-third-in-a-series.html


http://www.expiringmonthly.com/a-history-of-vix-futures-roll-yields.html

http://www.expiringmonthly.com/investing-implications-of-the-vix-term-structure.html


http://www.expiringmonthly.com/calculating-the-future-range-of-the-vix.html

http://www.cboe.com/LearnCenter/ViewSeminar.aspx?SeminarId=58

http://www.expiringmonthly.com/calculating-the-future-range-of-the-vix.html



http://www.expiringmonthly.com/a-history-of-vix-futures-roll-yields.html












went up nd so did voltility. Mkets wee stting to lm

down nd ten Septembe 11t ppened. as te mket

ws guing out Septembe 11t nd te eonomi issues

tt me wit it, we sw Enon blow up. (Figue 3)

It wsn’t until ely 2003 tt te mket nlly woked

toug ll of tese zy, voltile events. E one of tese

events seemed to led into note event nd so on. In mid-

2002 s Enon ws melting nd intenet ompny fte inte-

net ompny ws ollpsing, it ould ve been d fo

tde to imgine tt tis would end. Duing tt time, not

only ws 15 VIX buy, even 20 ws buy.

as te fe ound Enon, te dot-om bubble, nd te-

oism stted to subside, we enteed new peiod of low

voltility nd llying mkets. Fom ely ’03 until mid ’07

gin we ente note elly slow peiod. (Figue 4)

It tkes oil beking 120, te cinese eonomy slow-

ing, nd ogue tde to nlly get te mket to blow up

gin. Until tt ppened, gin we it peiod of time

wee tdes tougt 15 VIX ws big sle, let lone 20.

I emembe wen te VIX boke 10, we wee ll somewt

supised—but moe lmenting ow slow te mket ws.

as you n see, t te end of ’07 s oil is exploding nd

te ousing mket is stting to fll pt, we nlly see

te peiod of time tt is uently in eveyone’s mind. Te

US bnking isis nd te Euopen Soveeign debt isis.

(Figue 5)

Tis is note peiod wee tdes tink tt it is

impossible fo te VIX to be below 20, isis fte isis

seems to keep itting te eonomy, nd te wold. howeve,

tis is not going to lst foeve.

Looking bk, e of tese yles is bout 4–5 yes

long, we e bout 4 ½ yes into tis isis, te US eon-

omy is nlly getting bk on its feet. Bnks e pssing

stess tests (mostly); ou fiends oss te pond seem to

ve tei ouse in ode.

could it be tt we e eding into new peiod?

Te mket s been moving t snil’s pe tis ye.

Te tul ‘elized’ voltility of te mket ove te lst

3 monts s been less tn 12%. a VIX of 15 is moe tn

3% pemium to mket movement. Mybe VIX isn’t low

igt now. If we onside te VIX fowd-looking index,

mybe expettions of wt voltility will be going fowd

e low, nd te genel publi needs to t up to te

mjo investment ouses nd ms. EM

History of VIX (continued)

Figure 3

Figure 4

Figure 5




The Misunderstood

Hard-to-BorrowAndrew Giovinazzi

what is a d-to-boow (hTB)

stok? One ting I o tdes on is

spotting mket pttens in options. By

tt I men e uent mket voltili-

ties giving wy ny seets bout te

stok? Tee e sevel poduts now

tt igligt ode ow. In genel

tt is good ide sine seeing wee

te tion is lwys elps. Wen

stok goes hTB it leves n indelible

pint on te option voltility stutue.

Befoe I dive into tt, let’s exmine

te menis of hTB stok.

Mechanics

Te menil ftos in te m-

ket ple ve to do wit te leing

funtion. Essentilly tese e tings

tt e foed to ppen by viety

of tions on te pt of te leing

gent. assignment nd exeise e

note exmple of mket menis.

Te hTB omes bout wen stok o

seuity is evily soted. E seu-

ity needs to be loted nd boowed

befoe te undelying settles if te

selle wnts to sot it. Te leing

gent ndles tis funtion toug

te “Box” t te leing m s tey

keep tk of te boow-

ble nmes. If te Box n-

not lote te stok, te

lient wo s te sot

ses will be bougt in t

te mket. afte tding

t lest two dozen sot

squeezes I know fom

expeiene tt is neve t

good pie. Needless to sy te sot

leg of tde is now gone like pu of

smoke.

Market Impact

Wt does tis do to te seondy

mket fo te seuity? Well, ll of

sudden tee is s of buyes ty-

ing to lose sot positions like some

Teminto venously buying ses.

Up goes te pie. I ve seen sot

squeezes tt pused stoks up two

nd tee unded dolls fo weeks

t time. remembe sine tee e

only long selles elly ble to sell, te

upside gets little iy. Tis foed

buy-in is lled “sot squeeze” s

te sots get tei you-know-wts

nded to tem.

Cost of Carry Impact

Wt does tis do to te ost of y

of te options? Sevel tings, elly,

s te put/ll pity eltionsip

beome ftued. clls nd puts get

septed by te new, negtive ost

of y. Wen tdes look t option

seens tee is omputed ost

of y built into te option piing

model. Wen stok gets hTB, tt

negtive ost beomes te new vlue

in te model. So fo stok tt s

te font mont ombos tding fo $1

undewte, te new ost of y will

be -$1 nd so on fo evey stike in te

expition yle. Te lge tt bo-

ow gets, sy moving fom $1 to $2,

tt mens tee is moe pessue on

te sot to ove sine tee is less

stok vilble to boow. a uent

exteme sitution is in ShLD igt now

wit te apil boow t -$4. Fo now

it osts t lest 60% of te vlue of

ShLD pe ye to be sot te stok if

you bk te vlue out of te mket

pies. Tt is petty piey.

Volatility Impact

Te voltility impts e little de

to disen s one pltfom n ve

dieent intepettion of wt “fi

vlue” is fo te ost of y. If te

pltfom uses te uent boke dele

lon tes to impute ost of y, ll

of te puts fo hTB nme will look

vey expensive eltive to te lls.

hee is n exmple. (Figue 1) Note

te dieenes in te implied voltili-

ties in te iled olumns. Te put

IVs e bout twie te caLL IVs. Tis

mens te pltfom is unning no-

ml ost of y.

I ve seen sot

squeezes tt

pused stoksup two nd tee

unded dolls fo

weeks t time.




Now ontst tis seen wit

quote seen fom note vendo

(Figue 2). In tis se te vendo is

using ost of y eetive of te

mket onditions (te big negtive

boow) wi mkes te IVs fo te

lls nd puts ne te sme vlue.

In eite se te esy wy to

ek nd see ow f out of wk

tings e, just dd te aTM put pie

to te stok pie. ShLD ws td-

ing ound $80 so tt mkes te

synteti lls tding fo $8.5 o so.

Te tul lls e tding fo $4.85.

Eite wy tee is some big IV in

te option piing. One of te tu-

isms bout hTB nme is tt te IV

okets mostly beuse te isk of

squeeze up beomes d to quntify

long wit te poblems tt mde

te nme sot ndidte in te st

ple. a move in eite dietion is

likely to be violent.

Opportunities

Te hTB s few goodies tted

to it. Te biggest one is in te skew of

te options. Dietionl skew up nd

down s deent edge on it (note te

LIVEVOL sot, Figue 2). Sot tem

tio speds do not look too bd

eite s long s te isk n be eld

in ek. One of my fvoites

is tio ll sped tt buys ext

lls. Sometimes te upside gets

it d s te sots swit fom

stok to lls leving tem bit ep

eltive to wt is going on nd nie

enty points n pop up. Wit tis

position, just sitting nd witing fo

te squeeze to build n bing nie

ewds. EM

The Misunderstood Hard-to-Borrow(continued)

Figure 1

T h i n k o r S w i m

Figure 2

L i v e v o l




M O N T H LY F E AT U R E

what is the vrp? Te vine isk pemium n be

tougt of s te vege dieene between te voltility

you py fo nd te voltility eeived in ny kind of voltility

deivtive. In tems of tding options, tis pemium n be

onsideed te vege dieene between te voltility level

you bougt nd te tul voltility expeiene by te unde-

lying ontt duing te life of te option. One migt initilly

expet tt ove lge enoug smple size, te dieene

between tese two sould net out to be ppoximtely te

sme. ademi litetue nd el wold expeiene suggest

tt tis is typilly not te se, nd in ft te voltility

elized ove te life of ontt is often lowe tn te vol-

tility impliit in te initil pie of te ontt. Te mgni-

tude of tis dieene—te vine isk pemium—nges

fo dieent poduts, nd is n impotnt onept fo ny

ptiipnt in voltility mkets to undestnd. Wit te

dvent of te expnding wold of voltility deivtives, tis

ppe ttempts to undestnd tis pemium in VIX options.

by Reed Hogan, Guest Contributor




It is impotnt fo option mket ptiipnts to ve n

undestnding of te typil dietion of tis pemium nd

lso some guments fo its existene. ademis ve

used te caPM piing model nd omplex mtemtil

ppoes to peisely identify te soue of tis pemium,

nd it seems tt te ommon onlusion is tt tee e

mny soues fo te existene of te VrP. I ve found tt

bsi intuitive undestnding of te pimy soues of te

existene of te pemium sue in non-demi ontext.

One ommon explntion of negtive VrP is te neg-

tive oeltion between voltility nd etuns, wi mkes

voltility ssets poweful potfolio isk mngement tools.

Option buyes sould be willing to py pemium fo tese

ontts if te voltility tey puse seves to edue

tei ovell potfolio vine. Tis explntion eltes

te pemium to pusing insune, beuse buyes e

pying n dditionl ost to mnge ovell potfolio isk.

anote explntion fo te existene of tis pemium is

te skewness of etuns in voltility ontts. Voltility of

etuns is men- eveting, but pone to vey lge positive

spikes. Tis mens tt long position in voltility pod-

ut sould typilly lose smlle mounts of money, but is

vey potble wen voltility spikes. Fo te selles of vol-

tility poduts, egul pemiums ompenste tem fo te

isk of n infequent but vey lge loss in times of mket

unetinty.

How can you measure it and why should we

measure it in VIX options?

Dieent metods ve been used to nlyze tis pemium

in options. Bksi nd Kpdi (2003) used delt-edged

S&P 500 options to exmine te sign of te pemium. By

pusing options nd delt-edging tem wit te unde-

lying seuity, one n eetively edge out ll isk ote

tn voltility isk, so te pyo fom tese positions dete-

mines wete te elized voltility ws gete o less

tn te implied voltility of te ontt. Tese pyos

teefoe n be used s mesue of te dietion of te

pemium. Tey nd tt sttegy of delt-edging long

position in S&P 500 options undepefoms zeo, implying

tt option pies in genel inlude pemium ove te

expeted voltility duing te life of te ontt. Wile tis

metod suessfully gues tt te pemium is negtive,

it nnot quntify te pemium. E option ontt s

dieent veg— mesue of te sensitivity of option pies

to nges in voltility—wi would et te size of te

pemium fo dieent option ontts. Teefoe, te pyo

of delt-edged sttegy would not only be eted by te

pemium, but lso by te individul option ontt’s sensi-

tivity to nges in voltility.

Delt-edging options lso beomes vey diult wen

te undelying pie is not ontinuous, nd so te pyos

fom tis sttegy begin to eet te pemium less wit

moe pie gps. Tis penomenon n be esily illus-

tted by unning toug two exmples of delt-edging

simple ll, one wit ontinuous pie feed nd one

wit gps. Let’s ssume tt you e initilly buying 50

delt ll nd selling 50 ses of te undelying seuity

to emin delt neutl. Now ssume tt undelying pie

slowly difts up, nd you option position is now long 60

delts. as you option position ws slowly piking up delts

wit n inese in te stok pie, you wee slowly selling

moe ses ginst tese delts to emin delt neutl.

Tese ses e losing money s stok ineses. Now,

let’s ssume tt te pie nge ppened ovenigt,

so tt te next moning you option position ws long 60

delts nd you stok position ws still only sot 50 del-

ts. You only lost money on 50 ses s te stok went up,

te tn inesing you sot position s te stok went

up. Te pyos fom tese two positions e vey dieent,

nd illustte wy gps in te undelying pie n mis-

epesent te vine isk pemium being mesued by

delt-edged position.

Delt-edged single option positions n sy someting

bout wete te pemium is negtive o positive, but m-

ket ptiipnts would benet getly fom quntifying te

size of tis pemium. c nd Wu (2009) wee te st to

do tis nlysis by eting synteti vine swp tes

deived fom option pies. Te metodology tey developed

is bsed on te ide tt one n eplite te pyos of

Why VIX Options Are Richly Priced (continued)




vine swp losely by tding stip of out of te money

options wit stike squed weigts nd delt edging wit

te undelying seuity. Te pyo fom vine swp is

te dieene between te elized vine of n sset nd

pedetemined fowd-looking vine benmk, lled

te swp te. Te vege of tese pyos peisely me-

sues te vine isk pemium, nd is teefoe vey

useful tool to quntify te pemiums. Dt on vine

swps is not edily vilble, oweve, beuse tese on-

tts e tded ove-te-ounte (OTc) te tn toug

publi mketple. By syntetilly eting tese on-

tts, tis dt n be eplited fo ny sset, nd n

teefoe mesue te size of te vine isk pemium fo

ny sset.

So wy do we e bout vine swps? It is esy to

wite o tese poduts s exoti nd inessible to te

typil etil investo, but undestnding wt vine is

nd lso undestnding te unique teistis of tese

poduts elps to unlok extemely useful infomtion fo

ny voltility bsed deivtive. It is st impotnt to unde-

stnd tt vine is meely voltility squed. a voltil-

ity of 50% oesponds to vine of 25% (50% × 50%

= 25%), nd voltility of 150% oesponds to vine

of 225% (150% × 150% = 225%). Tese two exmples

lso igligt note impotnt teisti of vine:

Vine s onvex eltionsip to voltility. Figue 1

sows te pyo of voltility swp (blue line)

nd te pyo of vine swp (ed uve)

wit te sme stike. Voltility swps e mu

like vine swp in tt tey e initited

wit benmk voltility, nd te peson wo

is long te ontt is pid notionl mount

times te dieene between elized vol nd

te vol benmk. Notie tt te ed vine

swp line is gete tn o equl to te blue

voltility line t ll levels of voltility. Te on-

vexity of vine mens tt gins elete

t ige levels of voltility nd losses deele-

te t lowe levels of voltility if you e long

te vine swp. Tis nnot be te wy tese

ontts would be pied in el life, oweve, beuse

tee would be n instnt bitge eltionsip fom buy-

ing te vine swp nd selling te voltility swp wit

te sme stike. In ptie, te piing of vine swps is

djusted by moving te stike ige, sown in te gp s

te geen line. Notie tt te geen line s pyo of 0

t ige level of voltility, epesenting ige “bek-

even” voltility benmk. Te mount by wi

te vine swp wit te djusted stike (geen line)

undepefoms te voltility swp line (blue line) wen

te voltility swp s pyo of zeo is te vine isk

pemium.

Vine swps e lso useful beuse tey oe pue

exposue to voltility. Tding options lso gives tde

exposue to voltility, but te pyo of te position depends

on ote ftos s well, minly te pie of te undely-

ing seuity. Tis mkes tding vine swps te most

diet nd unontminted wy to tde pie voltility. Tis

lso mens tt vine swp dt povides te most le

infomtionl ontent bout te voltility of seuity, wi

n ten be pplied to ll vol deivtives.

Wile pevious ppes ve nlyzed tis pemium in

vious sset lsses, tis ppe mesues tis pemium

in te voltility sset lss by pplying simil metodol-

ogy to VIX options. Sine te ineption of VIX deivtives in

2004 (futues) nd 2006 (options), te tde volume in tese


Figure 1




ontts gew substntilly. Figue 2 sows te

gowt sine 2006 in VIX options, in tems of ll

nd put volume, nd VIX futues. Te vlues fo

2011 e extpoltions of te elized numbes

toug apil of 2011.

ative podut innovtion in te voltility

sset lss lso indites gowing demnd fo

voltility poduts. It seems tt evey dy tee

is new voltility ETN o ETF tt tks die-

ent pts of te VIX futue tem stutue wit

dieent leveges. reently, cBOE lso pplied

te VIX metodology to te Emeging Mket

ETF EEM nd dded futues nd options fo tis

index. It is le fom tese eent developments tt m-

ket ptiipnts e moe we of voltility s n sset lss

of its own nd e demonstting gowing inteest to tns-

t in tese poduts. Wit moe people ptiipting in te

VIX options nd futues mket, nd te voltility sset lss

moe bodly, it is impotnt to bette undestnd te pi-

ing of tese ontts. By mesuing te VrP in VIX options,

we ve one moe tool to nlyze edging o speultive

tdes in tese ontts.

Methodology Used

To ete synteti vine swp dt, you must detemine

n ute swp te nd mesue te elized vine

ove te life of tt ontt. To mesue te ltte, I simply

lulted te vine of te oesponding VIX futue los-

ing pies ove te ouse of te ontts life. Detemining

te swp te is mu tikie. Tis ppe dopts met-

odology developed by Mtysin1 wi pplies noml

distibution to vine levels oss dieently levels of

moneyness. Te integl of te esulting line, djusted fo

te fowd pie of te undelying ontt, utely

deives swp te.

Wile te mt used to deive te fomul n be little

bit messy, it mkes sense tt te swp te n be deived

fom option-implied vine. Sine no s nges nds

wen vine swp is initited, it follows tt te swp

te is onditionl isk-neutl expettion of te futue

vine of te undelying seuity. You n tink of te

metodology used in tis ppe s fomul to onvet te

option mkets expettion of futue voltility into te o-

et fomt fo vine swp.

DATA/Results

Using te metodology desibed in Tble 1, tis ppe

mesues te vine isk pemium in VIX options to be

3.27%. To put tt into ontext, ote ppes ve mesued

tis pemium using simil metodology fo te S&P500

(2.74%) nd DJIa (2.58%)2 nd even in ude oil (3.58%) nd

Ntul Gs (2.96%).3 Tis suggests tt te pemium in

VIX options is moe tn mket index pemiums nd on p

wit pysil ommodities. Te 3.27% vlue fo VIX options

suggests tt if you buy 100 doll vine swps on VIX

futues, you would lose on vege 3.27 dolls. as n option


Figure 2

rz i Vrp

Men Vine 0.595 0.628 -0.033

Men Voltility 0.771 0.792 -0.021

Stndd Devition 0.595 0.295 0.53

Skewness 2.402 2.306 2.488

rnge (Vine) 4.122 2.86 4.379

Minimum (Vine) 0.075 0.165 -1.011

Mximum (Vine) 4.197 3.025 3.367

Obsevtions 1107 1107 1107

TAble 1




mket ptiipnt, you n tink of tese esults in tems

of buying nd eeiving vine (emembe vine is

voltility squed); on vege, te potfolio of options tt

eplite te vine swp elized 2.1% less voltility tn

implied by tei pies.

Wile tis infomtion is useful fo nyone buying o

selling VIX options, n exmintion of te omponents of

tis dt is lso eveling. Te elized vine of VIX

options s n inedible nge duing te lifetime of tis

dtbse, wit minimum nd mximum vlue of 7.5%

nd 419%. To put tose vine tems into moe mnge-

ble voltility tems, tt oesponds to elized voltility

nge of 27% to 205%. conside lso tt te men el-

ized voltility ws ppoximtely 77%, mu lose to te

lowe bound of tis nge. Tis stongly suppots te ide

tt te vine isk pemium is egul pemium ol-

leted by te selle of voltility podut to ompenste

fo times wen voltility suges ginst tem. Tis expln-

tion is lso ppent in Figue 3, wi tks te umul-

tive PnL of te vine ontts. Note tt e dt point

eets te entie PnL esulting fom te dution of te life

of te ontt initited on tt dte. Te sw toot spe

of tis gp elps to demonstte ow egul pemiums

fom tese tdes n be ol-

leted, nd subsequently wiped

out wen vine spikes.

Looking t Figue 4, wi

sows times-seies of te pe-

mium itself, you n lso see

tis penomenon. Fo mu of

tis gp, te VrP is ove-

ing below zeo, but infequently

spikes substntilly.

Tis ppe lso n

egession of elized vi-

ne ginst te swp te to

detemine wete te pe-

mium vies wit egd to

time o te level of te swp

te. Te esults of tis eges-

sion suggest tt te vine isk pemium in VIX options

is eltively onstnt. Tis n most likely be ttibuted to

stong men evesion teistis in VIX option voltility.

In tis dtset, te stndd devition fo elized vine

(.595) is signintly ige tn te stndd devition

of te swp te (.295). Tis suggests tt elized vi-

ne nges in lge mgnitude tn te swp te, nd

indites tt te swp te djusts fo te futue men

evesion of voltility. It follows tt tis pemium sould be

eltively onstnt wit egd to time nd te swp te.


Figure 3 Simple Equity Curve – Short Var

Figure 4




Limitations to Consider and Conclusions

Wit ny demi ppe, it is impotnt to tink bout te

limittions in te metodology nd te implitions of pply-

ing te onlusions te ppe dws to el tding stte-

gies. In tis ppe, tee e some substntil limittions

to onside. If te ede is we of tese limittions, tis

sould not deese te infomtion ontent of te wok but

te put tt infomtion into te ppopite ontext.

Two of te lge limittions e elted to jumps in te

undelying seuity nd te ntue of te dtset itself. We

disusse elie ow jumps in te undelying pie feed

nge te pyos fom delt-edged potfolio. Fo vey

simil esons, tese jumps lso use te Blk-Soles

model to bek down. BS essentilly pies delt-edged

position in te option, nd implies voltility level equied

fo te undelying seuity in ode fo te position to bek

even given te mket pie of te option. If te delt-edg-

ing of tis position is less ute, so is te infomtion

ontent of te BS model. Tis metodology deives swp

tes fom te olletion of BS implied voltilities, so moe

fequent jumps mens less ute dtset. It is impo-

tnt to know tt VIX futues gp eltively fequently, nd

ontibute to inuies in tis nlysis.

Te exteme skewness in te elized vine of VIX

futues nd lso te vine isk pemium itself is some-

ting te ede sould lso onside. Wile tis is te

ntue of te dtset, nd lso ultimtely one of te ontib-

uting ftos to te existene of te VrP, it is good ptie

to tink bout ow tis ets te genelized onlusions

eed. Wit dtset tis skewed, one sould onside

te eet of te fequeny of spikes in elized vine.

Wt would ppen to te vege isk pemium if tis dt

set inluded one moe o one less voltility spike? cn we

expet te numbe of vine spikes tt oued in six-

ye dtset to eet te futue fequeny of su spikes?

Even toug tee is no igt nswe to tese questions, it is

impotnt to tink bout tese senios.

Tde sttegies speilly designed to ptue tis pe-

mium e diult, but not impossible, fo etil investos to

exeute. One would ve to sell out of te money options

in VIX options temselves, o possibly VIX ETF like VXX,

nd edge tem fequently wit te undelying seuity. Te

logistil poblems wit inititing sttegies like tese mke

doing tem in smll sizes diult nd likely not wot te

tnstion fees. It is lso impotnt to onside te vol-

tility envionment wen exeuting tese tdes. reently,

ontngo in VIX futues s been vey steep, suggesting

tt VIX options ve substntil pemium built into tem.

One most onside te benet of selling juiie option pe-

miums ginst te impliitly inesed ne of spike

in vine.

Tis ppe, nd demi ppes in genel, does not

povide le ut, lp geneting tding sttegy

but te povides one moe piee of infomtion fo te

infomed etil investo to tink bout. Wile tee n be

some gument bout te uy of te ext VrP in VIX

options, tee is stong evidene to suggest tt te pe-

mium is onsistent nd signint. To ptue tis pemium

wit tding sttegy, te genel gol sould be to net

sell VIX option pemium, wit stong weness of te

infequent nd vey lge spikes in elized vol. Fo investos

wo e exeuting ote tding sttegies o edging pot-

folio etuns, knowledge of tis pemium n elp to ontex-

tulize te best wy to t on you investment tesis. EM

Reed Hogan graduated from Claremont McKenna College

in 2011 with a BA in Economics and Finance. He cur-

rently works as a clerk at a proprietary option trading rm

in Chicago.

1 c, Pete, nd roge Lee. “Voltility Deivtives.” annul

review of Finnil Eonomis 1 (2009): 319–39.2 Wu, Liuen nd c, Pete P., Vine risk Pemi (Otobe

24, 2007). aFa 2005 Pildelpi Meetings. avilble t SSrN:

ttp://ssn.om/bstt=577222 o ttp://dx.doi.og/10.2139/

ssn.577222

3 Tolle, andes, nd Edudo Swtz. “Vine risk Pemium

in Enegy commodities.” Jounl of Deivtives 17.3 (2010):

15–32. ttp://s.ep./les/ontent/sites/s/les/uses/192823

publi/TolleSwtz_Enegy_Vine_risk_Pemi.pdf


http://ssrn.com/abstract=577222

http://dx.doi.org/10.2139/ssrn.577222


http://sfi.epfl.ch/files/content/sites/sfi/files/users/192823/public/TrolleSchwartz_Energy_Variance_Risk_Premia.pdf






http://ssrn.com/abstract=577222




Expiring Monthly Interview with

Mark LongoMark Sebastian

I have known Mark Longo for some

time; he and I are co-hosts of the

Option Block podcast and Volatility

Views. While some may think he is

simply a marketing guru, the fact

is that there is no one in the nan-

cial media that has a stronger under-

standing of the derivative markets,

exchange politics, and social media

than Mark. His site is a must read on

a daily basis for any serious options

trader. I sat down with him and asked

him a few questions:

expn Monthy: Please describe

The Options Insider.

Mak lono: We e leding soue

fo fee infomtion bout te options

mket. We ove eveyting Fom

bsi edution to unusul tivity,

dvned tde mngement, nly-

sis nd beking news. Ou udiene

uns te gmut fom etil to insti-

tutionl, wit gowing numbe of

nnil dvisos nd sset mnges

town into te mix. We fute dif-

feentite ouselves fom te ines-

ingly owded online options spe

by limiting ou ontibutos to peo-

ple wit ptil bkgounds in te

options mket. We lso opete te

wold’s only dio netwok devoted to

options tdes. as esult, we oupy

eltively unique spe witin te

options wold.

eM: What caused you to get into this

business?

Ml: Wen we stted building Te

Options Inside in 2006, vey few out-

lets povided fee ess to options

infomtion. Most websites ged

fo options ontent o used it to up-sell

tei ote options poduts/sevies.

So we sw n oppotunity to ete

someting dieent tt ws essi-

ble to ll options uses. We luned in

Jnuy of 2007 nd ve been going

stong eve sine.

eM: What makes The Options Insider

dierent from other new aggregators?

Ml: We luned te site pimily

ound oiginl options ontent. Tt

ws simply beuse so few outlets

wee opeting in te fee ontent

en to ny signint extent. as te

yes pssed nd moe options desti-

ntions me online, we begn pt-

neing wit tose destintions to dd

tei ontent to ou oeing. Now, Te

Options Inside s gown to beome

fntsti ggegto of online options

infomtion s well s soue of om-

pelling oiginl ontent. Ou gol is to

povide ou udiene wit one-stop

sop fo ll of te best infomtion

fom te options mket.

eM: Where is nancial news heading?

Ml: Sdly, te dys of oiginl on-

tent e fding. Most nnil news

sites simply oe links to outside on-

tent tese dys long wit te bility

to omment on tose links. So, wile

we endevo to povide ou udiene

wit uted snpsot of ggegted

options ontent evey dy, we lso

ontinue to invest in ompelling oigi-

nl ontent oss viety of medi-

i n t e r V i e w

Mark S. Longo is the founder of

TheOptionsInsider.com, the pre-

mier destination for options infor-

mation. An options trader and

former member of the Chicago

Board Options Exchange, he

is also the co-founder of The

Options Alliance, a consortium

of options publishers, brokers,

exchanges and vendors.

http://www.theoptionsinsider.com/





ums. Ou dio netwok is pefet

exmple of tt. We spend signi-

nt mount of time nd esoues

eting oiginl dio ontent evey

week. Unfotuntely, tt level of om-

mitment to oiginl ontent is e in

te moden nnil news en.

eM: What has been the impact on

podcasting for your business and

the industry?

Ml: Ou dio netwok s temen-

dous impt on ou business. It is

signtue pt of Te Options Inside

bnd. Mu of tt impt stems

fom te ft tt we wee mong

te st to podst bout options nd

ve been doing it fo ove ve yes.

We e lso te only ones to oe

dio netwok tgeted t te options

udiene. as smtpone doption

inesed in eent yes, podsting

beme n even moe eetive tool

fo eing out to nie udienes

like options uses. Tee will etinly

be mny moe esoues devoted to

tis medium in te yes to ome.

eM: What information do you nd

most valuable to your readers?

Ml: Unusul tivity is still ou most

popul ontent oeing beuse it

its ll options demogpis. Wete

tey’e sesoned po o novie

etil tde, eveyone wnts to know

bout te ot options tivity of te

dy. We’e lso fousing on dvned

tde mngement ontent mu

moe (gmm slping, djustments,

et.) beuse tt is n extemely

impotnt e tt is itilly unde-

seved t te moment.

eM: What is the current climate for

the exchanges right now?

Ml: In mny wys it is e to te

bottom, wit moe exnges devoting

esoues to ttting “noise volume”

su s dividend tdes, fee bitge,

et. Tt volume boosts tei mket

se nd tei bottom line, but ep-

esents little tul ustome tivity

o eonomi intent on te pt of te

end-use. We nd tis tend distub-

ing beuse tis volume does little to

expnd te options mket by ttt-

ing new ustomes o bodening te

ppel of te podut. In mny wys, it

tively disenfnises oe onstitu-

enies su s liquidity povides nd

etil ustomes.

eM: What is next for the exchanges,

there seem to be M-T exchanges

popping up everywhere, can the

traditional PFOF model last?

Ml: It etinly seems tt M-T

exnges oeing ggessive ebtes

nd teing to nie goups like hFTs

will be te tend going fowd. It’s dif-

ult to see ow tditionl exnges

suvive witout dilly nging

tei business models nd ustome

bses to eet tis new elity.

eM: You are kind of known as an insid-

er’s guide to the exchanges, what are

your thoughts on the SEC investigation

into CBOE?

Ml: all infomtion points to te ft

tt it’s enteed ound te cBSX

igt now. But it’s n extemely uid

sitution tt ould nge t ny

moment.

eM: Now that the NYX-DB deal

fell through, what is next for the ISE?

Ml: Tt is te million-doll question

in t options spe igt now. ISE’s

mket se s tended downwd

in eent yes. Tei pent om-

pny, Euex, s been foed to wite-

down signint losses on te initil

puse pie of te exnge. Te

NYSE/DB mege would ve povided

ISE wit ess to new tenology nd

moe esoues. Wit tt o te tble

nd wit so mny m-t exnges

ting up to, o even supssing, ISE

in mket se, it’s d to see wi

wy ISE goes fom ee.

eM: What do you think could be the

next major change in trading over the

next few years?

Ml: Te uent tend of non-tdi-

tionl soues of “liquidity” usuping

tditionl mket mkes will only

exebte in te oming yes.

Tis inevitble tend s distub-

ing implitions fo te futue of te

options mket, ptiully in illiquid

lsses o on dys of exteme voltil-

ity. If you e n tive options tde,

ptiully multi-leg sped tde,

ten tis tend will impt you in te

ne futue if it sn’t ledy. EM

Expiring Monthly Interview with Mark Longo (continued)





Slow

DaysAndrew Giovinazzi

as the vix briefly dipped

below 15% tis week it mde me tink

bout ow I used to pss te time

on slowe dys wen I ws mket

mke. Tee is misoneption bout

oo tding in tt it is busy nd e-

ti ll of te time. Tt is not entiely

tue. Wen te voltility dies down

nd some of te sesonl slowness

omes in te ype goup of den-

line junkies known s oo tdes nd

temselves wit ext time on tei

nds nd not mu to do. Sue te

mket is tding nd tiking but wt

elly ounts is te veloity of odes

itting tding oo t ny one time.

If tt veloity slows to tikle some-

ting s to give.

Tink of tding oos s big loke

ooms sine it is mostly men (some

women). Tis is goup pedisposed

to betting so wen te quiet omes

guys stt to ome up wit inteesting

tings to bet on. Tis sene ws mde

fmous in Li’s Poke in te lte 80s.

Te bond tding oom t Slomon

Botes d some impomptu Li’s

Poke fo big buks. Floo tdes

looked fo moe inteesting tings

to bet on sine pt of te gol ws

to kill time. hlf of te fun ws om-

ing up wit someting good to bet on.

Nomlly it d to onsist of someting

veible on te oo itself. Tt ws

pt of te fun. also tee ws usully

some sot of mildly sdisti qulity to

it. Sine tee ws stedy stem of

leks wo needed ext doug tee

usully ws lwys willing tke.

Tke one of my fvoites. Send

lek ound to ollet bids to sve

tei ed. Fist, some time got killed

nding lek wo would sve tei

ed fo money. You tow out ou-

ple of bids, $100, $200 et nd no tk-

es. Ten te guys would get togete

nd up te nte bit, sy $500, nd

still noting. rmp it up to $1000 nd

ten tee ws some inteest. afte

ll, tt ws tip to Mexio so wt

is wong wit sved ed nywy?

One ou lte te lek omes bk

bld s ue bll. Most of te dy ws

ppily ove.

Eting ontests wee petty popu-

l too. Eting ot sue o dinking

gllon of milk, stu like tt. Te cBOE

s tis get lun oom wit wll to

wll windows so membes ould et

lun nd keep n eye on te tion in

tei owds. It ws one of my fvoite

ples to ve lun (besides cees).

On slow dy we me up wit n

ide of eting 50-piee ciken

MNugget box in one ou fo $500. I

tougt no wy ould nyone do tt.

We ppened to be luky enoug to

ve uge kid fom te Sout

Side leking in te pit next to

us. his boss, te boke, lled

im Tiny. he ws not tiny. he

took te bet like it ws te

esiest money e ws eve

going to mke. We deided to

ve te ontest in te mem-

bes lounge nd I wnted to

see Tiny et te nuggets fom

te pit sine I ould not leve

te DPM. he ws stnding by

te window wolng down tose nug-

gets. Te st 30 minutes olled by

nd e d sfed down lf of tem

nd ws looking stong. It ws impes-

sive. 40 minutes into it e stted to

slow down, elly slow down nd now

te 20 MNuggets left looked s big s

bseblls to Tiny. he sipped some milk.

Tt ws bd ide beuse t bout

minute 50 e ould not et one moe. I

know beuse e tied to et one moe

nd out tey me ll ove te mem-

bes lounge window. It ws spetul

Only one ou to go in te dy nd te

lose looked like it ws eting up.

as tding note, be eful fding

in quiet mket s tings n nge

in uy one some liquidity stts to

sow up. EM

f l o o r s t o r i e s

afte ll, tt ws

tip to Mexio sowt is wongwit sveded nywy?




Taking Advantage of a

NewsletterMark Sebastian

there are good newsletters nd tee e

bd newslettes, it n be vey diult to gue out one

fom note. howeve, tee e times wen it n be

extemely esy to gue out bd one s well. Fo sttes,

tis sounds ounteintuitive, but one does not wnt lette

tt is followed by too mny tdes, beuse someting

like wt ppened in Dr hoton on M 8t migt p-

pen to you.

DhI is not smll omebuilde, but it is lso not extly

supe tive option eite. Te cBOE lists it s lss c,

mening mid-tie tivity. Wit n vege volume of little

ove 9,000 ontts dy, it n ndle big odes, but not

hUGE odes. Tus, wen mjo newslette lled fo its

tdes to buy te DhI apil 14 puts someting got om-

pletely out of wk.

Notie ow open inteest nd IV spiked wen te eom-

mendtion me out.

as tdes bougt up te puts, tey begn to dmti-

lly sift te movement in voltility on te stike. Tis

used te ‘sks’ to ome swimming, nd petty soon,

investos wo tougt tey wee getting get puse

ween’t getting su get puse. In ft, I would ven-

tue to sy tt side fom owning aaPL lls t ny pie

(lmost joke tee) selling te apil 14 puts migt be te

best lyup of te ye fo tese tdes. hee is ow tey

tded it.

Wen te tdes st stt seeing te ode ow ente

DhI, ll on one stike, ll to buy, tey know someting is up.

Finding out bout te newslette (wi tey quikly do),

te tn sell options to te tdes buying on te news-

lette eommendtion, te sks BUY stike ne te

suggested stike in n ttempt to get ed of te newslet-

te lemmings. a tde migt buy 100 of te DhI apil 15

puts nd edge te tde delt neutl (buying 6800 ses

of stok).

One ommissions e ftoed in te tde pys bout

33% voltility on te tde.

as te volume on te options ineses nd te voltil-

ity of te 14 puts explodes te tde nlly pulls te tigge

on selling te puts one te IV is up enoug. Te tde sells

enoug so tt e n unwind is stok position nd get

sot veg (sensitivity to nges in implied voltility).

f o l l o w t h a t t r a d e

Figure 1

L i v e V o l P r o

Figure 2

Figure 3 Prot/Loss by Change in DHI Common Price

Figure 4




Te new position looks like tis:

It’s essentilly font sped. he mnges it by tking

it o wen IV flls, o by tding delts ginst te gmm.

Ou initil puse of 100 puts is up bout 300.00.

One te tde entes te sle, witin n ou, te IV

s stted to deline. Wit IV in te tde now s some

deisions to mke on tis position. On 258 ontts te

tde is up 700.00 (not bd fo 2 ous wok).

at tis point te tde n eite ut bit, edue te

position, o let it ide. Tt is n entiely dieent FTT. Fo

ou puposes we sut te doo on tis tde. EM

Taking Advantage of a Newsletter (continued)



http://vixandmore.blogspot.com/



Freedom To vs.

Freedom FromBill Luby

the cold war ws n e in

wi wfe ws wged on mny

fonts, wit te onit of ides nd

pilosopy often seving s poxy fo

toops, tnks nd even nule-tipped

wepons.

One of te moe inteesting pilo-

sopil skimises fom tis e

involved two ompeting oneptions

of libety: positive libety nd neg-

tive libety. Fo tose of us wo eside

in pedominntly demoti pitl-

ist ntions, te

dominnt teme

is positive libety,

wi is essen-

tilly te bil-

ity to exeise

ou fee will in

n envionment

in wi indi-

vidul libeties,

pesonl oie

nd self-eliz-

tion e enou-

ged nd te

estitions upon

tose libeties

by te stte e

eltively lim-

ited. Te ip side of positive libety is

negtive libety, in wi obstles o

estitions to tose individul oies

e emoved o minimized. Pt of te

gument in fvo of negtive libety is

tt one wo s food, ousing, elt

e, edution, employment nd

ote neessities povided fo tem is

fee fom ving tei desied pusuits

estited by tose nd ote ftos.

Duing te cold W, te negtive lib-

ety gument ws te Soviet Union’s

ejoinde to te Westen lmoing fo

moe libety nd umn igts.

I mention ll tis s I ve eently

been tinking get del of te

distintion between positive libety

(feedom to) nd negtive libety (fee-

dom fom) in te ontext of invest-

ing. I believe tee is n investing

lifeyle. Most of us stt ou invest-

ment ees wit miniml mount

of pitl nd expetise. Ove time

we identify es in wi we ve n

edge nd we inopote tose into

ou sttegi ppo. as ou skill nd

expetise multiplies, so do ou ount

blnes—fo te most pt.

Pt of te iony of tis develop-

ment poess is tt s we quie

moe skill nd expetise, mny of us

beome less inlined to put tem into

tion, s isk vesion gows nd

etun of pitl begins to tke pe-

edene ove etun on pitl. Wen

I ws in my twenties, I wnted to it

te bll out of te pk evey time I

me to bt. Now tt I m in my f-

ties, I m beginning to see te ppel

of just mking sue I dvne te un-

ne nd not it into n inning-ending

double ply.

Wen it omes to investing, plying

defense is not s mu fun s plying

oense, just s

tying to void

twisted nkle is

lot less fun tn

tying to limb

ugged moun-

tin. conside,

oweve, tt

te feedom to

isk lf of one’s

tding ount

on single td-

ing ide my

ultimtely be

less impotnt

tn te feedom

fom blowing

up, sueing

lge dwdown o peps even being

foed to seek out note ee.

a good tde must nd te blne

between feedom to nd feedom fom

nd be willing to develop skills nd

expetise in bot es. Wile

tpeze tist pefoms wit sfety

net, tt sfety net sould mke it

esie to e fo te eetofoe

untinkble. EM

B a c k p a g e

Te iony of tis development

poess is tt

s we quie

moe skill ndexpetise, mny

of us beome

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