On September 12 at the 7th Annual Cboe European Risk Management Conference (RMC), Bill Speth, Global Head of Research on the Cboe Multi-Asset Solutions Team, delivered a presentation on Developments in Volatility-Related Indicators & Benchmarks. Bill’s presentation covered the following topics --
- A look into the many volatility indicators that exist; how they were created and for what purposes
- VIX® Index, RVX Index (Russell 2000 vol), VVIX Index (VIX of VIX), SKEW Index, and correlation and dispersion indexes
- How to interpret what volatility measures really mean and are helpful for signaling market information
- Market structure changes including bank capital regulations and how indicators may be impacted
CBOE VVIX INDEX (VIX OF VIX INDEX)
The Cboe VVIX Index measures “volatility of volatility” –in this case, expected volatility of the 30-day forward price of the VIX Index -the price of a hypothetical VIX futures contract that expires in 30 days. www.cboe.com/VVIX. VVIX is calculated using the VIX methodology applied to near-and next-term VIX options. VVIX is not the same as the expected volatility of the “spot” VIX Index, but the two are related. 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 ≈ 0.80. The highest 10% of VVIX values are associated with an average VIX Index value of 28; six of highest VVIX values occurred in February 2018 (record 180 on Feb 8).
VVIX INDEX AND GAUGING THE COST OF BUYING VIX OPTIONS FOR PROTECTION
Bill Speth had a novel slide that covered these topics - What VIX options can be bought for 50 cents? What is the impact of VVIX Index price levels on VIX option pricing? Bill provided a chart with these estimates (1) if the VVIX Index is at 80, one could buy VIX call options at a strike price of around 18, and one would need a 32% move in the VIX Index to break even; and (2) if the VVIX Index is at 120, one could buy VIX call options at a strike price of around 29, and one would need a 111% move in the VIX Index to break even. Note that the numbers in the previous sentence are estimates, and the actual experience of investors can differ.
CBOE SKEW INDEX (SKEW)
The Cboe S&P 500 Skew Index (SKEWSM) -derives expected skewness (“tail risk”) of the S&P 500 using a portfolio of SPX options. www.cboe.com/SKEW
- Like the VIX Index, SKEW Index uses 30-day options and range of strikes can vary
- SKEW Index is a statistical measure of expected probability distribution of SPX
- Statistic converted to index: SKEW = 100 –10 * price of skewness
- SKEW Index methodology reflects expected probability of “outlier returns” –moves of 2 or more standard deviations
- SKEW Index is based on SPX option quotes that have a non-zero bid
- Structural issues may be influencing SKEW levels: (1) Minimum tick size $0.05, (2) Supply of out-of-the-money (“OTM”) options limited by high cost of capital and risk management practices; (3) few traders can sell uncovered OTM puts; (4) liquidity providers are subject to Dodd-Frank capital charges; and they may demand more edge in light of these requirements.
- Skew measures didn’t foresee February 2018 correction due to changes in demand for OTM SPX call options; recent demand for OTM SPX calls has been driving SKEW Index lower.
VIX FUTURES TERM STRUCTURE
- Mean reversion and long-term uncertainty drive VIX futures term structure.
- When VIX spikes, shorter-dated futures are more responsive because there is less time for VIX Index to mean revert.
- “Roll-Down” premium (difference between front, second VIX futures prices) is the greatest in contango.
DRIVERS OF CORRELATION
- SPX volatility risk premium (‘VRP’) is 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
- In 2017 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)
CBOE S&P 500 IMPLIED CORRELATION INDEXES (ICJ,KCJ, & JCJ)
The Cboe S&P 500 Implied Correlation Indexes (ICJ, KCJ, JCJ) measure changes in the relative premium between index options and single-stock options. www.cboe.com/ICJ
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 50 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.
To learn more, please visit the links below -
Options strategies http://www.cboe.com/strategies