Trading Volatility with VIX Futures and Options

Peter LuskInstructor

The Options Institute at CBOE

Trading Volatility

with VIX Futures and Options

CHICAGO BOARD OPTIONS EXCHANGETrading Volatility – 2

Disclosures

In order to simplify the computations, commissions have not been included in the

examples used in these materials. Commission costs will impact the outcome of all stock

and options transactions and must be considered prior to entering into any transactions.

Multiple leg strategies involve multiple commission charges.

Any strategies discussed, including examples using actual securities and price data, are

strictly for illustrative and educational purposes only and are not to be construed as an

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Copyright © 2009 Chicago Board Options Exchange, Incorporated. All rights reserved.


Session Outline

The VIX Index – What is it?

VIX Futures & Mini-VIX Futures

What You Need to Know

A Market-Timing Tool?

VIX Options

Unique Pricing Aspects

Trading Case Study


The CBOE Volatility Index

VIX - The CBOE Volatility Index

A measure of 30-day implied volatility

Created in 1993 by CBOE & Duke University

Goal: to trade and hedge against changing

implied volatility

Originally based on OEX options (S&P 100)

2003 – New formula with SPX options (S&P 500)


0

200

400

600

800

1000

1200

1400

1600

06/03/08 07/03/08 08/05/08 09/05/08 10/07/08 11/06/08 12/09/08 01/12/09 02/12/09 03/17/09 04/17/09

-10.00

10.00

30.00

50.00

70.00

90.00

110.00

130.00

150.00

170.00

190.00

SPX

VIX

VIX & SPX 5/1/08 to 4/30/09


VIX and the S&P 500

Also known as the “Fear Index,” VIX gives

an indication of options market anxiety.

VIX tends to rise as the S&P 500 falls

A “low” VIX indicates complacency.

A “high” VIX indicates anxiety.

VIX readings are very difficult to interpret as

an indicator of market direction.


VIX Futures

Launched March, 2004

Mini-VIX futures added March, 2009

Unique pricing and price behavior


VIX Futures – Contract Specs

Ticker Symbol VX

Underlying VIX Index

Last Trading DayTuesday, 31 days before next

SPX expiration

ExpirationWednesday morning 30 days

before next SPX expiration

Settlement$1,000 VIX calculation based

on opening SPX option prices


Mini-VIX Futures – Contract Specs

Ticker Symbol VM

Underlying VIX Index

Last Trading DayTuesday, 31 days before next

SPX expiration

ExpirationWednesday morning 30 days

before next SPX expiration

Settlement$100 VIX calculation based

on opening SPX option prices


VIX / Mini-VIX Futures – More Facts

Cash Settlement

Quotes in Nickels

VIX Futures – 7 contract months

Mini-VIX Futures – 3 contract months


Margin Requirements

VIX Futures Mini-VIX Futures

Long / Short $8,000 $800

Spreads $500 $50

Note: margin requirements may change.


15

17

19

21

23

25

27

29

31

33

35

9/2

4/2

007

10/8

/2007

10/2

2/2

007

11/5

/2007

11/1

9/2

007

12/3

/2007

12/1

7/2

007

12/3

1/2

007

1/1

4/2

008

1/2

8/2

008

2/1

1/2

008

2/2

5/2

008

3/1

0/2

008

3/2

4/2

008

4/7

/2008

4/2

1/2

008

5/5

/2008

5/1

9/2

008

6/2

/2008

6/1

6/2

008

6/3

0/2

008

7/1

4/2

008

7/2

8/2

008

8/1

1/2

008

VIX Index

Aug Futures

VIX compared to Aug 08 VIX Futures


VIX compared to Feb ‘09 VIX Futures

15

25

35

45

55

65

75

85

8/4

/08

8/1

8/0

8

9/1

/08

9/1

5/0

8

9/2

9/0

8

10/1

3/0

8

10/2

7/0

8

11/1

0/0

8

11/2

4/0

8

12/8

/08

12/2

2/0

8

1/5

/09

1/1

9/0

9

2/2

/09

2/1

6/0

9

VIX Index

Feb Futures


VIX Futures vs. VIX Index

No traditional futures-to-cash relationship!

No cost-of-carry relationship.

The current VIX futures price is the

market’s estimate of what the VIX Index

will be at settlement.

VIX Futures prices based on expectations.


(non-) Correlation

VIX futures trade independently of the VIX

Index prior to expiration.

VIX futures can trade above or below the

VIX Index.

Convergence at expiration.


Date Mar Fut VIX Index

03/05/09 47.35 50.17

03/12/09 41.10 41.18

03/20/09 47.05 45.89

Last trading day, 3/24; Final settlement, 3/25

VIX Futures vs. Index Sample Dates


VIX Futures Spreads

The price of a VIX futures is based on

expectations.

Therefore, the spread between one futures

contract and the next contract can change.

Trading VIX futures spreads may be an

opportunity (with the attendant risks).


VIX Futures Spreads

Apr - Mar

Date Mar Fut Apr Fut Spread

2/17/09 48.00 44.05 3.95

2/20/09 46.70 44.75 2.95

2/24/09 44.50 43.90 1.60

2/25/09 43.45 43.25 0.20


VIX & VIX Futures – 3/18/09

VIX Index 40.79 -2.94

April VIX Futures 43.05 +1.45

May VIX Futures 40.10 +0.95

June VIX Futures 38.80 +0.60

What does that tell us?


A Market-Timing Indicator?

Lawrence McMillan cited in Barron’s, 4/6/09:

“The relationships are fluid….., but the upshot is

that when longer-term VIX futures are priced at a

substantial and/or persistent premium to shorter-

term VIX futures and VIX itself, it portends a

volatile and usually weaker phase ahead for

stocks.”

Page 15, “Today’s Indexes Look Familiar” by Michael Santoli


VIX Futures Spreads

SPX & VIX Spreads Aug - Dec 07

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

08/21/07 09/21/07 10/23/07 11/23/07 12/26/07

1100

1150

1200

1250

1300

1350

1400

1450

1500

1550

1600

3rd - Front

3rd - VIX

SPX

Spreads SPX


VIX Futures Spreads

SPX & VIX Spreads Dec 07 - April 08

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

12/18/07 01/22/08 02/22/08 03/26/08 04/25/08

800

900

1000

1100

1200

1300

1400

1500

1600

3rd - Front

3rd - VIX

SPX

Spreads SPX


VIX Futures Spreads

SPX & VIX Spreads April - Aug 08

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

10.00

12.00

04/22/08 05/22/08 06/24/08 07/25/08 08/26/08

800

900

1000

1100

1200

1300

1400

1500

3rd - Front

3rd - VIX

SPX

Spreads SPX


VIX Futures Spreads

SPX & VIX Spreads Aug - Dec 08

-40.00

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

08/21/08 09/23/08 10/23/08 11/24/08 12/26/08

200

400

600

800

1000

1200

1400

3rd - Front

3rd - VIX

SPX

Spreads SPX


VIX Futures Spreads

SPX & VIX Spreads Dec 08 - April 15, 2009

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.00

12/02/08 01/05/09 02/05/09 03/10/09 4/9/2009

400

500

600

700

800

900

1000

3rd - Front

3rd - VIX

SPX

Spreads SPX


VIX Futures Spreads

SPX & VIX Spreads APR 09 - JUL 09

-4

0

4

8

12

4/1/2009 4/20/2009 5/9/2009 5/28/2009 6/16/2009 7/5/2009 7/24/2009

300

400

500

600

700

800

900

1000

1100

4th - Front

4th - VIX

SP 500

Spreads SPX



VIX Index 36.50 +0.42

May VIX Futures 37.00 +0.55

JuneVIX Futures 36.90 +0.95

July VIX Futures 36.83 +0.13

Has the market changed from 3/18 to 4/30?



VIX Index 25.98 +0.12

Sep VIX Futures 28.60 +0.55

Oct VIX Futures 29.55 +0.40

Nov VIX Futures 29.20 +0.35

Is the market different on 8/12?


VIX & Mini-VIX Futures – Summary

Prices of VIX futures are based on expectations.

VIX futures prices can trade above or below the

VIX Index.

Ticker Margin

VIX futures VX $8,000

Mini-VIX futures VM $800

VIX futures spreads $200

The relationship of back-month futures to the

VIX index might give a clue to market direction.


VIX Options

Launched February 24, 2006

Symbol – VIX

Cash-settled, European, $100 multiplier

1-point strikes below 20; 2½ above

6 expirations available (3 near term plus

3 in February quarterly cycle)


VIX Settlement (at Expiration)

VIX expiration is the Wednesday 30 days

prior to the next month’s option expiration.

Last trading day is the Tuesday before the

Wednesday VIX option/futures expiration.

Settlement based on VIX calculation using

next-month options (e.g., June VIX

settlement uses July SPX options)


VIX Options – Pricing 1

Date: 3/10/08

Current VIX Index 25.46

May 30 Call 2.70

May 30 Put 3.40

Is there anything unusual about these prices?


VIX Options – Pricing 2

Date: 8/12/09

Current VIX Index 25.55

Sep 30 Call 1.90

Sep 30 Put 3.70

Is there anything unusual about these prices?


Inputs to Option Prices

Underlying Price

Strike Price

Time to Expiration

Interest Rates

Volatility


VIX Case Study

Date 2/27/08 (90 days to May exp.)

VIX Index 22.69

VIX MAY Futures 22.58

VIX MAY 22.50 Call 3.40


VIX Case Study – the Forecast - 1

Date 2/27 3/10

VIX Index 22.69 29.38

May Futures 22.58 ???

May 22.50 Call 3.40 ???


VIX Case Study – the Forecast - 2

Date 2/27 3/10

VIX Index 22.69 29.38

May Futures 22.58 25.46

May 22.50 Call 3.40 5.40

NOTE: The 22.50 Call appears to be trading

below parity to the VIX index!


Case Study – Observations

With approximately 90 days to expiration,

the VIX futures changed less than the

VIX Index.

Traders of VIX options must pay attention

to the price of the VIX futures contract.


Summary

VIX is an index of implied volatility of SPX

options.

VIX has been negatively correlated to the

market.

Futures and options contracts have unique

specifications.

The “underlying” for VIX options is the same

expiration VIX futures contract.


Trading Volatility

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Documents

Trading Volatility with VIX Futures and Options