For more information on the CBOE Volatility Index^® ("VIX"), volatility and variance futures including brokers, ISVs, symbols and product specifications, visit www.cboe.com/cfe.

To contact the CFE, please click here.

Futures in Volatility includes several sections: Market Summary and Analysis, Trading Strategy Ideas, and Events. Market Summary and Analysis includes commentary related to VIX, VIX futures and other volatility products, as well as charts and data related to these markets. Trading Strategy Ideas features strategies focused on trading volatility products. And, Events features upcoming CFE and Chicago Board Options Exchange (CBOE^®) conferences, seminars and webinar presentations.

Back to top

Contact Information

Please direct questions concerning this circular to Jay Caauwe at (312) 786-8855 or caauwe@cboe.com.

VIX Futures Last Trade Dates

Announcements

CFE plans on listing Binaries on CPI and Housing Starts. Watch this space for more details!

The CFE is moderating a Professional Overview of Volatility Futures and Options panel at the GAIM Fund of Funds Conference

Market Summary and Analysis is provided by Larry McMillan. Mr. McMillan is the President of McMillan Analysis Corporation. Click Here for more information about Mr. McMillan.

Historic Discounts on VIX Futures

As the broad stock market S&P 500 Index^® (SPX) went into a volatile tailspin, volatility derivatives proved to be useful as hedges and as market predictors. In the course of these developments, CBOE Volatility Index^® (VIX^®) futures traded at a historically large discount to the VIX itself and, acted as a harbinger of the large rally that occurred during the third week in September.

Things have changed considerably in a month, which is not uncommon in a volatile market. In last month's report (August), we reported that VIX futures were building up a fairly large premium as the market continued to rally off the July lows. Since then, a major about-face has occurred. The S&P 500 Index stalled out in August, first going sideways for a few weeks, and then breaking below support of 1260 on Thursday, September 4th. Since then, volatility has increased dramatically while the S&P 500 Index made a wild round trip down to 1130 and back up again to 1260 by Friday, September 19th.

The premium that had existed on the front-month September VIX futures in late August disappeared when the S&P 500 Index broke downward in early September. As the decline deepened, the VIX began to rise slowly at first, and then rapidly during the third week in September. The futures did not keep pace, as is habit, and what had been a premium on the futures turned into a discount. Table 1 shows the current term structure of the four nearest-term VIX futures contracts.

What is interesting is the premium on the front month October VIX futures over this time period. Table 2 shows certain dates, comparing the VIX and the October futures on those dates. You can see you the discount widened to its eventual historically deep discount, with a 9.61 discount close on Wednesday, September 17th. Prior to this recent period, the deepest closing discount on a front-month VIX futures contract had been 3.62, in November, 2007.

Intraday, the discounts were even bigger when the VIX reached 42 during trading on Thursday, September 18th. At that time, the October VIX futures only managed to rise to about 28, so the intraday discount was a significant 14 points.

As we have pointed out in the past, when the futures trade at deep discounts it is a short-term bullish sign for the broad market. The market normally begins to rally strongly within 3 days of the initial significant discount. Once again, that proved to be true although there were some steep declines before the rally got started. Even after the large rally that ended the week, these futures are still trading at significant discounts. Based on history, that should be bullish for the market until the discounts disappear.

What Is Causing These Discounts?

They are largely due to the way that the various entities are computed. The VIX is a calculation using S&P 500 Index October and November options (as of this date). October futures, however, reflect only the November S&P 500 Index implied volatility. Remember that the futures expire 30 days prior to the next S&P 500 Index option expiration, therefore October futures are hedged with November S&P 500 Index options. Essentially, this is saying the October S&P 500 Index options are much more expensive than the November S&P 500 Index options, which they are.

Term Structure

Rather than talk about a strategy today, let's examine another useful piece of data that VIX futures provide. The term structure of the futures is their relationship to each other. That is shown in Table 1 for one point in time. Here we use the closing prices of Wednesday, September 17th. It can also be instructive to see how the term structure changes over time. Figure 1 below shows how the term structure has changed in the last month.

On the chart, there is a vertical line with arrows at each end, indicating the market interpretation of changes in the term structure. If the market is rising, the term structure will be downward. That is why the bullish arrow points down. Conversely, if the market is falling, the term structure will rise, and hence the bearish arrow points up. Let's see how this worked in actual practice this month.

On August 11, the S&P 500 Index reached the high for the July-August rally, trading at 1313 that day. The term structure shows a bullish bias at that point, with the VIX being lower than all the futures, and each successive future trading at a slightly higher price than its predecessor (yellow line).

The S&P 500 Index was rather stagnant for a couple of weeks, but by August 26th, it had started to slip and was trading at 1280. The term structure didn't move much, edging only slightly off its most optimistic lows (brown line). The index then broke down below support, and by September 9th, the VIX was rising and so were most of the futures prices (green line).

Even though the S&P 500 Index decline had began to accelerate, the term structure remained rather flat on September 12th (red line), with the VIX edging slightly above the futures contract. For all intents and purposes, the future price during September was virtually all equal to the deferred contracts. Then, over the weekend of the 13th and 14th, the government did not bail out Lehman Brothers (LEH). At that point, a certain amount of panic began to appear in the marketplace as the S&P 500 Index started to drop quickly. And for that day and the next two days, the VIX exploded and the futures contracts followed it higher. This accelerated the movement of the term structure in the bearish direction (higher).

From here, it is hard to imagine the term structure moving much higher. It is overbought at these levels. It is more likely that it would start to decline, perhaps not dramatically, but at least enough to flatten out the structure somewhat.

About CBOE Futures Exchange

CBOE Futures Exchange (CFE^®) is an all-electronic open access exchange, which utilizes the CBOE’s^® state-of-the-art trading system, CBOEdirect^®. CFE is the leader in providing innovative volatility risk management futures products, including VIX^® and variance futures, which enable market participants to manage volatility risk, as well as trade volatility directly. Access to CFE is available through numerous brokers, ISVs or directly via the CBOEdirect API or CBOE’s HyTS^® terminals. CFE trades are cleared by the AAA-rated Options Clearing Corporation (OCC). To contact the CFE, please click here.

About Larry McMillan and McMillan Analysis Corporation

Professional trader Lawrence G. McMillan is perhaps best known as the author of Options As a Strategic Investment, the best-selling work on stock and index options strategies, which has sold over 200,000 copies. An active trader of his own account, he also manages option-oriented accounts for certain individuals and in addition, he is the Portfolio Manager of The Hardel Volatility Arbitrage Fund (a hedge fund). In a research capacity, he edits and contributes to his firm’s publications: Daily Volume Alerts, The Option Strategist and The Daily Strategist—derivative products newsletters covering equity, index, and futures options. Finally, he speaks on option strategies at many seminars and colloquia in the United States, Canada, and Europe. He is quoted in publications such as The Wall Street Journal, Barron’s, Technical Analysis of Stocks and Commodities, Data Broadcasting’s Exchange magazine, Futures Magazine, theStreet.com, and Active Trader Magazine. In these capacities, he is the President of McMillan Analysis Corporation, which he founded in 1991. Prior to founding his own firm, Mr. McMillan was a proprietary trader at two major brokerage firms—primarily Thomson McKinnon Securities, where he ran the Equity Arbitrage Department for nine years.

Back to top

*     This is a paid advertisement. The inclusion of these advertisements should not be construed as an endorsement of any product, service, or Web site or as an indication of the value of any claims, recommendations or other information contained therein.

Copyright © 2008 CBOE Futures Exchange, LLC. All rights reserved.

CFE®, CBOE®, Chicago Board Options Exchange®, CBOE Volatility Index®, VIX® are registered trademarks of Chicago Board Options Exchange, Incorporated.

The information in this newsletter is provided solely for general education and information purposes and therefore should not be considered complete, precise, or current. Many of the matters discussed are subject to detailed rules, regulations, and statutory provisions that should be referred to for additional detail and are subject to changes that may not be reflected in this newsletter. The strategy discussions contained in this newsletter are designed to assist individuals in learning how volatility and variance futures as well as other volatility-based derivatives work and understanding various volatility derivatives strategies. The strategies discussed are for educational and illustrative purposes only and should be not be construed as a recommendation to buy or sell a security or futures contract or to provide investment advice. Additionally, commissions and other transaction costs have not been included in the example strategies and will impact the outcome of security and futures transactions and must be considered prior to entering into any transactions. Investors considering volatility-based derivatives should consult a professional tax advisor as to how taxes affect the outcome of contemplated transactions in volatility-based derivatives. The charts and/or graphs contained herein are intended for reference purposes only. Past performance is not indicative of future results.

The views of third party contributors to this newsletter are their own and do not necessarily represent the views of CFE or its affiliates. Third party contributors are not affiliated with CFE. This newsletter should not be construed as an endorsement or an indication by CFE of the value of any third party product or service described in this newsletter.

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 (ODD). Copies of the ODD are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606.

The methodologies of the CBOE Volatility Index (VIX) and the CBOE DJIA Volatility Index (VXD) are owned by CBOE and may be covered by one or more patents or pending patent applications.