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.

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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

OptionsCity^TM Now A Certified CFE Vendor; OptionsCity Metro Trading Platform Offers Users Trading and Market Making Capabilities on the CBOE Futures Exchange (CFE)

CFE'S SEPTEMBER AVERAGE DAILY VOLUME RISES 60% OVER YEAR AGO; Month Was Most Active In 2008, Third Busiest Month Ever at CFE, Year-To-Date Volume 26% Ahead of 2007

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.

The Wildest Month on Record

The selling in the broad stock market S&P 500® Index (SPX^SM) has continued at an even greater pace in the last month, with the VIX® and its derivative products exploding to new heights as a result. Some of the behavior in these products was extreme, to say the least. The bottom line, however, is that the derivatives behaved more or less as they are supposed to in times of crisis. They did so by providing excellent hedges and protection for stock owners and anyone else seeking protection from increased volatility. Of course, speculators who traded VIX from the long side did well also.

The discounts on the various VIX futures reached levels never seen before. The October contract settling this past Wednesday morning at 63.04 was the highest VIX settlement on record. It had traded at a substantial discount to VIX even during its last days. For example, at the close on Friday, October 17th, with only two more trading days left until expiration, the October futures settled at a discount of 7.08. From the inception of VIX futures over four years ago, and until just a few weeks ago, we had never seen a discount of that size on any futures contract, much less one that was going to expire in a matter of three days.

And longer-term contracts have remained at heretofore unthinkable discounts. For example, the November VIX futures traded at a 31-point discount to VIX today. Table 1 shows a snap shot of the discounts using settlement prices from today, Friday, October 24th.

Clearly, traders are not paying up for S&P 500 Index options expiring past the nearest month, which are the driving force behind the VIX calculations. Remember that VIX itself is a weighted, 30-day volatility, using, at this time, the strips of November and December S&P 500 Index options. Experienced VIX traders also keep an eye on VIN, the VIX of the near-term options (November, in today's case) and VIF, the VIX of the far-term options (December, in today's case). They help to explain the difference between VIX and the front-month futures.

Even so, these discounts are huge. Eventually, this will likely prove bullish for the broad market as those discounts are saying that VIX will decline to meet the futures contracts. And, when VIX declines, the broad market rallies. However, they were saying that last month, too, and they were wrong.

Term Structure

The term structure is stretched, even more so than last month. Figure 1 shows the development of the current, very steeply sloped term structure from the last time it was flat, in mid-August. This graph clearly shows how VIX represents near-term volatility, and the futures represent something else.

For example, last August if you had felt that VIX was going to increase sometime in the next six months, you might have decided to buy a February 2009 VIX futures contract to express that opinion. You would have been disappointed if you had. The February VIX futures have advanced from approximately 23 to 35 as VIX has exploded from 20 to 70. The much better choice is the near-term futures contract, for it will always mirror VIX movements better. So, the better strategy is to buy the near-term futures contract when you are trying to express an opinion on VIX and just keep rolling it over from month to month. You would thus have bought October futures at 23 and they settled at 63.04 this week.

A Strategy

What can one do now? There is a useful strategy that seems to have a good chance of making money: buy both VIX calls and S&P 500 Index (or SPY) calls. November calls could be used in both cases. The VIX calls have a built-in edge, in that November futures (which will settle to the same underlying VIX calculation as the November VIX calls) are trading at such a substantial discount to VIX. Furthermore, this market is clearly oversold and may be ripe for a monster oversold rally. Typically such rallies occur right at the end of October. So, one side or the other of this hedge should make money. The other side, even if it expires worthless, has limited risk since it is a call option.

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.

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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.