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The New Volatility Futures
by Larry McMillan
They just might be the stock owner's delight.
The CBOE has created a new futures exchange
(the CBOE Futures Exchange, or CFE) to trade volatility products. Its first
and only product at this time is futures on VIX, the CBOE volatility index,
but the CBOE plans to introduce more volatility-related products soon.
Some traders might dismiss these products as simply an opportunity for
option-crazed investors. But in reality, these products will find application
for a far wider audience than speculators: stock owners can benefit from
the ability to hedge their portfolios against volatility risk. In many
cases, that translates into a hedge against a falling market. For this
reason, the CBOE expects these products to be quite successful eventually.
This article will lay out the basics of the futures, discuss some strategies,
and show how a conservative volatility hedge would have worked over the
last 10 years.
MECHANICS OF THE CONTRACT
Introduced in 1993, the VIX was created to measure implied volatility
of OEX options. In 2003, the CBOE changed the VIX to be the measure of
implied volatility of Standard & Poor's 500 Index (SPX) options. The
"old" VIX became VXO, and that index still measures the implied volatility
of OEX options.
To implement the VIX futures, a new volatility index called the Jumbo
CBOE Volatility Index (symbol: VXB) has been introduced. VXB is equal to
10 times VIX. Futures on the jumbo VIX are worth $100 per point of movement
of VXB, so one futures contract will make or lose $1,000 when VIX moves
by one full point (from 15.00 to 16.00, for example).
These futures trade with the base symbol VIX, and expire in February,
May, August, and November. In addition, there is a contract in each of
the two nearest months not included in that February cycle. Four months
are available for trading at any one time. So if today were June 1, there
would be contracts expiring in June, July, August, and November.
The minimum tick in the volatility futures is 0.10 (which is the same
as 0.01 for VIX) and is worth $10. Currently, not all quote vendors are
disseminating quotes on these futures, because it is onerous for a vendor
to set up the software to handle a new exchange when that exchange has
only one product. However, as the CFE introduces more products and as they
gain popularity, that drawback will be overcome.
The VIX futures have slightly different expiration dates than CBOE-listed
index options. The last trading day will be the Tuesday immediately before
the third Friday of the expiration month.
Figure 1: History of $VXO. Notice how it trades at all
different levels? This makes it difficult to set a fixed level for buy
and sell signals.
...Continued in the August issue of Technical Analysis of
STOCKS & COMMODITIES
Excerpted from an article originally published in the August 2004
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights
reserved. © Copyright 2004, Technical Analysis, Inc.
Return to August 2004 Contents
