Q&A
Futures For You
Inside The Futures World
Want to find out how the futures markets really work?
DeCarley Trading senior analyst and broker Carley Garner responds to your questions
about today’s futures markets. To submit a question, post your question
at https://Message-Boards.Traders.com. Answers will be posted there, and selected questions will appear in a future issue of S&C.
VIX FUTURES
How can I trade Vix futures?
On March 26, 2004, the Chicago Board Options Exchange (Cboe) listed a futures contract with its volatility index (Vix), often referred to as the fear index, as the underlying asset. Although the Vix has been in existence for some time, it wasn’t always tradable via futures contracts. As is the case with any new listed product, liquidity has been an issue for Vix speculators; however, volume and open interest are on the rise.
That said, don’t make the mistake of attempting to trade the miniversion of the Vix. It is common to see fewer than 20 contracts traded in a session and the lack of volume in the minicontract creates large bid/ask spreads, increasing the intrinsic costs of participating in the market. This might make exiting the trade difficult and expensive in fast-moving market conditions.
The value of the Vix is relative to real-time prices of options on the Standard & Poor’s 500 (Spx) also listed on the Cboe. The Vix is intended to reflect the investor’s consensus view of future market volatility over the next 30 days or so and will fluctuate with the implied volatility built into option pricing.
Implied volatility is exactly what the name implies; it is the volatility implied by the market price of an option. If market participants are expecting higher volatility, they will bid the price of corresponding options higher. This is because the rights involved in owning those options are more valuable in active markets. From a mathematical viewpoint, it is the volatility value that yields a theoretical value of a particular option equal to the current market price when a pricing model such as Black–Scholes is used.
If you have been trading options for a while, you may have noticed that put options tend to trade at higher prices than call options. This phenomenon is a function of the market’s implied volatility and can be explained at least partly by the assumption that markets tend to go down faster than they go up and thus the market typically values put ownership higher than call ownership. In the case of the S&P 500 (remember the Vix is based on S&P option pricing), many options are purchased as insurance policies against a declining market. Most investors don’t ensure themselves against a bull market, but some prefer protection against a bear and doing so can drive up the price of puts.
Knowing this, it makes sense to infer that the Vix will increase quicker in a declining market than it will in an inclining market. Unlike the S&P, in which prices tend to fall faster than they rise, the Vix tends to rally faster than it declines. It is this negative correlation that opens the door to cross-speculation.
Vix speculators are free to buy or sell futures in anticipation of future price movements; however, liquidity is a real concern in many scenarios. Accordingly, an alternative to trading the Vix directly is speculating in the index indirectly through the Cme’s emini S&P 500 futures and options. A trader who believes that the Vix will increase likely also believes that the S&P will fall. A trader might be interested in buying puts on the S&P, selling futures, selling calls, or a combination of these. Choosing the emini as opposed to the Vix futures products provides traders with ample liquidity to enter and exit positions nearly 24 hours per day (Vix futures only trade during a day session) and with little in the way of bid/ask spreads.
Note that the S&P futures don’t always trade perfectly inversely to the Vix. Trading S&P futures as a means of speculating in the Vix doesn’t provide traders with a pure Vix play. Nonetheless, it is a viable candidate.
DOING RESEARCH
Is it possible to look up the work history of my commodity broker?
I agree it is important to know, and hopefully trust, the person you have chosen to work with you and your hard-earned money. It is wise to have a nonintrusive but thorough conversation with your broker to give you an idea of the background of the person you are dealing with. In addition, the National Futures Association (Nfa) provides access to the work history of each individual and firm registered with the Cftc.
The Background Affiliation Status Center (Basic) is accessible on the Nfa’s website (www.NFA.futures.org) and enables traders to review the registration and Nfa membership information of firms and brokers. This includes the length of your broker’s time in the business as a registered member of the regulatory bodies and a list of any regulatory actions. Listed actions include Nfa arbitration awards and Cftc reparation cases involving the broker or firm.
It is important to realize that listed Cftc reparations do not imply guilt. A displayed claim may have been settled, dismissed, or withdrawn but will be on the Basic record of the broker for as long as the database is available. While the intention is to protect investors, it can sometimes result in false assumptions regarding the ethics of some industry insiders. Therefore, I recommend you discuss any possible infringements with your broker; it is only fair you get his or her side of the story.
The Nfa’s online Basic database also provides traders with information on any Nfa arbitrations. Unlike the previously discussed Cftc reparations that involve a possible infraction of regulation, Nfa arbitration is a dispute resolution forum. Naturally, you would want to know whether your broker may have been party to questionable practices in the past. However, simply being part of an arbitration hearing might not translate into any wrongdoing. There is substantial risk in trading options and futures. It is not suitable for everyone.