Volatility Indexes and
Portfolio Management
September 27, 2007 at the CBOE
QWAFAFEW / PRMIA - sponsored Panel Discussion on
Portfolio Management and the Volatility of Volatility Indexes
Overview of Volatility Markets
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$80 - $100 MM Vega traded globally each day.
Vanilla variance swaps most common, but growing interest in
variance options, conditional variance, corridor variance, correlation
& dispersion and VIX. Some forward starting variance products.
Growing demand for long-dated options (>10 yrs.)
Expiry ranges from 1 month to 10 years. Most activity is 3 months to
1 year.
Hedge funds, mutual funds, pension funds, insurance companies
hedging equity volatility risk. Non-equity & fixed income managers
looking for uncorrelated returns. End-user groups slowly
broadening, still learning & need to identify risks and benefits.
Volatility buyers might become sellers if risk/return is right.
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Why Trade Volatility?
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Negative correlation to most equity indexes
Positive correlation to credit prices
Efficient way to manage unwanted market risk
Unique properties of volatility create trading
opportunities
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Historical difference between realized and implied
volatility
Volatility Term Structure
Volatility of Volatility
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Volatility Indexes at the CBOE
Index
Ticker
Underlying
Index
Futures
Ticker
Website
CBOE Volatility Index
VIX®
SPX
VX
www.cboe.com/VIX
CBOE DJIA Volatility Index
VXD
DJX
DV
www.cboe.com/VXD
CBOE NASDAQ-100 Volatility Index
VXN
NDX
VN
www.cboe.com/VXN
CBOE Russell 2000 Volatility Index
RVX
RUT
VR
www.cboe.com/RVX
CBOE S&P 100 Volatility Index
VXO
OEX
No futures
www.cboe.com/VXO
Index
®
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Unique Features of Volatility
Index Products
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Futures Pricing Based on Forward Value
of Volatility Index
Pricing Can Be Different for a Number
of Reasons
Wednesday Settlement
Special Opening Quotation Price
Negative Correlation to Stock Indexes
High Volatility of Volatility
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VIX and S&P 500 Since 1990
75
1800
S&P 500
(SPX)
50
1200
SPX
VIX Daily Closing Prices
VIX and S&P 500
25
600
VIX
0
0
Sources: CBOE and Bloomberg. (Jan. 2, 1990 - Sept. 24, 2007).
www.cboe.com/VIX
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CBOE's Volatility Indexes in 2007
40
Daily Closing Prices
RVX
VXN
30
VIX
VXD
20
10
0
1/3/2007
3/12/2007
5/16/2007
7/23/2007
Sources: CBOE and Bloomberg.
(Jan. 3, 2007 - Sept. 24, 2007)
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VIX Spot, Futures & Options in Feb.-Mar. 2007
On Feb. 27 the S&P 500 fell by 3.5%, the VIX Index rose 64%,
and VIX Mar. 07 futures were up 29.5%.
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VIX Spot
15
3/16/2007
3/2/2007
VIX Nov '07
Futures
2/15/2007
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2/1/2007
10
VIX Mar '07
Futures
On Feb. 27 the March '07 15.0 VIX calls rose 483%.
2.5
VIX May
'07 15.0
Calls
2.0
1.5
1.0
VIX
March '07
15.0 Calls
0.5
0.0
3/16/2007
3/2/2007
2/15/2007
2/1/2007
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% Change in Prices on 27 Feb. 2007
S&P 500 (SPX)
VIX Nov '07 Futures
VIX Mar '07 Futures
-3.5%
3.2%
29.5%
VIX Spot Index
64.2%
VIX May '07 15.0 Calls
77.3%
VIX March '07 15.0 Calls
483.3%
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VIX – Futures vs. Spot
Daily Closing Spot Prices and
Futures Settlement Prices
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72% increase in VX
futures prices from
July 10 to Aug. 15.
30
VIX Spot
VX Futures
25
20
Futures expired on
Wed. Aug. 22.
8/21/2007
8/14/2007
8/7/2007
7/31/2007
7/24/2007
7/17/2007
7/10/2007
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(July 10 - Aug. 22, 2007).
Sources: CBOE and Bloomberg.
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RVX – Futures vs. Spot
Daily Closing Spot Prices and
Futures Settlement Prices
40
37.36
70% increase in RV futures
prices from July 10 to Aug. 15.
35
30
RVX Spot
RV Futures
25
20
8/21/2007
8/14/2007
8/7/2007
7/31/2007
7/24/2007
7/17/2007
7/10/2007
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Futures expired on
a.m. Wed. Aug. 22.
(July 10 - Aug. 22, 2007).
Sources: CBOE and Bloomberg.
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VXN – Futures vs. Spot
Daily Closing Spot Prices and
Futures Settlement Prices
30
25
VXN Spot
VN Futures
20
8/21/2007
8/14/2007
8/7/2007
7/31/2007
7/24/2007
7/17/2007
7/10/2007
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Futures expired on
a.m. Wed. Aug. 22.
(July 10 - Aug. 22, 2007).
Sources: CBOE and Bloomberg.
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VXD – Futures vs. Spot
Daily Closing Spot Prices and
Futures Settlement Prices
30
25
VXD Spot
DV Futures
20
15
8/21/07
8/18/07
8/15/07
8/12/07
8/9/07
8/6/07
8/3/07
7/31/07
7/28/07
7/25/07
7/22/07
7/19/07
7/16/07
7/13/07
7/10/07
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Futures expired on
Wed. Aug. 22.
(July 10 - Aug. 22, 2007).
Sources: CBOE and Bloomberg.
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Negative Correlations
Negative Correlations
The VIX and S&P 500 Indexes had a negative correlation of
daily returns (-0.86) in the first half of 2007.
0.5
VIX and SPX
VXD and DJX
RVX and RUT
VXN and NDX
0.0
-0.5
-0.76
-0.83
-0.82
-1.0
2004
2005
2006
-0.86
Jan-Jun07
Correlation of Daily Returns for Volatility and Stock Indexes.
Source: CBOE.
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High Volatility of Volatility
Volatility of Volatility Indexes
160%
142%
VIX
120%
VXD
95%
78%
85%
RVX
80%
VXN
40%
0%
2004
2005
2006
Jan.-Jun07
Historic Volatility of Daily Returns of Volatility Indexes. Source: CBOE.
In 2006 the historic volatilities of daily returns were -- 95% for spot
VIX, 46% for VIX near-term futures, 32% for Google, and 10% for
the S&P 500 Index.
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Volatilities of VIX, Stocks, & Stock Index
Historic Volatilities in 2005 and 2006
2005
2006
VIX Spot Index 83.3% 94.2%
VX Near-Term
45.8% 56.0%
Futures
GM
42.6% 41.3%
AAPL
38.8% 38.1%
GOOG
32.1% 34.0%
IBM
17.9% 14.2%
S&P 500 (SPX) 10.3% 10.0%
Source: CBOE Research.
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VIX Options Volume and Open Interest
VIX Options
4,000,000
Open Interest
3,000,000
Total Volume
2,000,000
1,000,000
A
S
O
N
D
J
F
M
A
M
J
J
A
(April 2006 - August 2007). Source: CBOE.
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Premiums Received in a BuyWrite Program
Often Rise When VIX Rises
Excerpted from BXM study by Callan Associates (available at www.cboe.com/BXM).
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Other Volatility-related Indicators
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CBOE S&P 500 3-month (and 12-month) Variance Futures based
on the realized, or historical, variance of the S&P 500 Index.
RUG: An indication of the realized variance of the S&P 500 Index
that has been accumulated so for in the life of the front-month
futures contract.
IUG: An indication of the future variance of the S&P 500 Index that
is implied by the daily settlement price of the front-month variance
futures contract.
CBOE S&P 500® VARB-XTM Strategy Benchmark tracks the
performance of a hypothetical volatility arbitrage trading strategy
designed to capitalize on the historical difference between SPX
option implied volatility and the realized, or historical, volatility of the
S&P 500 Index.
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Papers on Volatility
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Antognelli, Ferreira, McArdle, and Traub. "Fear and Greed in Global Asset
Allocation." The Journal of Investing. (Spring 2000), pp. 27 - 32. VIX "is a good
indicator of the level of fear or greed in U.S. and global capital markets. When
investors are fearful, the VIX level is significantly higher than normal. Market
participants require additional compensation in the form of above-average
excess returns for riskier assets. … Using implied volatility as an asset allocation
factor would have added significant value over the last thirteen years."
Rattry and Balasubramanian. “The New VIX® as a Market Signal – It Still
Works!” Goldman Sachs Options and Volatility Report. (Sept. 5, 2003). (1) A
high level of the New VIX has a similar power in predicting the market’s
subsequent direction as the Old VIX. On average, the S&P 500 has risen after
the New VIX reached extreme levels, with a more frequent positive return the
more extreme the New VIX level. (2) A low level of the New VIX has not been a
consistently successful indicator of subsequent market weakness. (3) A
reversion of the New VIX occurs both after upside and downside extremes. …
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Recent 10-Page Paper
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Goldman Sachs US Options Research (Aug.
14, 2007). “… Investors have been turning to
VIX futures and VIX options to position long
volatility during the recent pullback. VIX
options were the 2nd most liquid index
options contract in July behind the S&P 500.
We compare the recent performance of SPX
puts versus VIX call options and find that VIX
calls offered a superior return per dollar
invested. …”
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Topics for Discussion
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-- In light of the fact that the volatility indexes already have experienced
greater-than-ten-percent daily moves in more than thirty days in 2007,
how can investors and traders benefit from these big moves?
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-- How are the futures and options on the volatility indexes priced?
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-- Have the volatility indexes seen explosive upside moves when stock
prices recently declined?
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-- Is volatility a powerful unique new asset class?
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-- Is a high VIX level a bullish signal and a low VIX bearish for stocks?
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-- Can the volatility index products be used as tools for diversification,
asset allocation, and/or market forecasting?
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The prices for the futures and options on volatility indexes have some unique features;
please visit www.cboe.com/volatility for more details.
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,
http://www.cboe.com/Resources/Intro.asp which is available from your broker, by calling 1-888OPTIONS, or from The Options Clearing Corporation, One North Wacker Drive, Suite 500, Chicago, IL
60606. The information in these slides is provided solely for general education and information purposes and therefore should not be considered
complete, precise, or current. Past performance is not a guarantee of future returns. Many of the matters discussed are subject to detailed rules,
regulations, and statutory provisions which should be referred to for additional detail and are subject to changes that may not be reflected in these
materials. No statement within these materials should be construed as a recommendation to buy or sell a security or to provide investment advice.
Any strategies discussed, including examples, do not include commissions, dividends, margin, taxes, and other transaction costs. However, these
costs will affect the outcome of transactions and should be considered. For further information regarding the tax effects of transactions, consult your
tax advisor. The methodology of the CBOE volatility indexes is owned by CBOE and may be covered by one or more patents or pending patent
applications. Supporting documentation for claims, comparisons, statistics or other technical data is available by calling 1-888-OPTIONS, sending
an e-mail to help@cboe.com , or by visiting www.cboe.com/bxm . S&P 100TM® and S&P 500TM® are registered trademarks of McGraw Hill, Inc.
and are licensed for use by the Chicago Board Options Exchange, Incorporated. CBOE®, Chicago Board Options Exchange®, CBOE Volatility
Index®, VIX®, and OEX® are registered trademarks and VXDTM VXOTM VXNTM RVXTM and SPXTM are trademarks of Chicago Board Options
Exchange, Incorporated. All other trademarks are the property of their respective owners. Copyright © Chicago Board Options Exchange®,
Incorporated, 2007. All Rights Reserved.
www.cboe.com/volatility
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