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New Volatility Index Futures for Oil & Gold
As the VIX languishes in the doldrums
of teen spirit, lulling market participants to sleep before volatility
comes screaming back to life, the CME & CBOE have announced a
partnership that will create futures (and options on futures) for
volatility indexes across a variety of asset classes. Beginning with
Oil, Gold, Corn and Soybeans, these new derivative instruments are
scheduled for launch in Q3 of 2010. Each benchmark index will be
established upon the CBOE Volatility Index® (VIX®) methodology
and price series will originate from CME Group options on futures
contracts via the most active electronically traded front and nearby
contracts.
[1] CME press release
[2] Crude Oil, Gold & Euro Volatility Index charts
[3] CBOE primer on just what the heck the VIX actually is
CHICAGO, March 5 -- CME Group, the
world's leading and most diverse derivatives marketplace, today
announced it has entered into a seven-year license agreement with the
Chicago Board Options Exchange (CBOE) that will allow CME Group to list
futures and options on futures for volatility indexes on a variety of
asset classes. These contracts will be listed with, and subject to, the
rules and regulations of the particular exchange where the products
will be traded (CME, CBOT or NYMEX).
"Our liquid and transparent commodity
and financial markets are the foundation for the creation of new
indexes that customers can use to gain a view on volatility across a
wide array of asset classes," said Scot Warren, CME Group Managing
Director of Equity Index Products and Services. "We believe that a
reliable benchmark index for volatility sentiment on contracts such as
WTI Crude Oil, Corn, Soybeans and Gold will help market participants
make more effective investment and hedging decisions based on their
exposure to market volatility."
Terms of the license agreement between the exchanges include the following:
- CBOE will create, own and calculate the benchmark indexes using its established CBOE Volatility Index® (VIX®) methodology and license use of the indexes to CME Group.
- The benchmark indexes are scheduled to begin publishing data during the third quarter of 2010.
- Prices
used in the calculations will originate from CME Group options on
futures contracts. The data will use the most active electronically
traded front and nearby contracts across commodity and financial
products.- CBOE will be the initial market disseminator of prices for the volatility indexes. {1}
Crude Oil Volatility Index ~ Daily
Gold Volatility Index ~ Daily
Euro Currency Volatility ~ 240-minute
For a primer on what the CBOE Volatility Index (commonly known as 'the VIX') actually is, we turn to the CBOE itself.
1. What is VIX?
The CBOE Volatility Index - more
commonly referred to as "VIX" - is an up-to-the-minute market estimate
of expected volatility that is calculated by using real-time S&P 500® Index (SPX)
option bid/ask quotes. VIX uses nearby and second nearby options with
at least 8 days left to expiration and then weights them to yield a
constant, 30-day measure of the expected volatility of the S&P 500
Index.
2. How is VIX calculated?
Calculation is independent of any
theoretical pricing model, using a formula that averages the weighted
prices of at-the-money and out-of-the money puts and calls to derive
expected volatility. More information and a sample calculation may be
found at the VIX White Paper [attached below].
3. How do VIX options allow me to trade volatility
The VIX formula isolates expected
volatility from other factors affecting option prices, such as changes
in underlying price, dividends, interest rates and time to expiration.
As such, VIX options offer a way for investors to buy and sell option
volatility simply and directly, without having to deal with the other
risk factors that would otherwise have an impact on the value of an SPX
option position.
4. I'm used to options expiring on the third Friday of each month. Why do VIX options expire on a Wednesday?
VIX was designed to be a consistent,
30-day benchmark of expected market volatility, as measured by SPX
option prices. Of course, there is only one day in the life of any
option that is exactly 30 days to expiration, so in order to arrive at
the 30-day standard, VIX is calculated as a weighted average of options
expiring on two different dates.
One day each month, on the Wednesday
that is thirty days prior to the third Friday of the following calendar
month, the SPX options expiring in exactly 30 days account for all of
the weight in the VIX calculation. VIX options settle on these
Wednesdays in order to facilitate the special opening procedures that
establish opening prices for those SPX options used to calculate the
exercise settlement value for VIX options.
5. Will VIX options always reflect current, real-time VIX values?
Probably not, at least not until you
get close to expiration. The underlying for VIX options is the
expected, or forward, value of VIX at expiration, rather than the
current, or "spot" VIX value. This forward value is estimated using the
price quotations of SPX options that will be used to calculate the
exercise settlement value for VIX on the expiration date, and not the
options used to calculate spot VIX. For example, VIX options expiring
in May 2006 will be based on SPX options expiring 30 days later - i.e.;
June 2006 SPX series. In fact, June SPX options do not even enter into
the spot VIX calculation until April 17, 2006.
Some VIX options investors look at the prices of the VIX futures to gain a better general idea of how the market is estimating the forward value of VIX.
VIX option prices should reflect the
forward value of VIX, which is typically not as volatile as spot VIX.
For instance, if spot VIX experienced a big up move, call option prices
might not increase as much as one would expect. Depending on the value
of forward VIX, call prices might not rise at all, or could even fall!
As time passes, the options used to calculate spot VIX gradually
converge with the options used to estimate forward VIX. Finally, at VIX
options expiration, the SPX options used to calculate VIX are the same
as the SPX options used to calculate the exercise settlement value for
VIX options.
6. How is the exercise settlement for VIX options calculated?
The exercise settlement value for VIX
options (Ticker: VRO) is a Special Opening Quotation (SOQ) of VIX
calculated from the sequence of opening prices of the SPX options used
to calculate VIX at settlement. Most of the SPX option opening prices
typically reflect actual trades. The opening price for any series in
which there is no trade is deemed to be the mid-quote price, the
average of that option's bid and ask prices. Only series with non-zero
bid prices upon completion of the special SPX opening procedures are
used in the SOQ calculation.
7. How is the calculation of
hte VIX SOQ different than the calculation of other VIX values? What
can this mean for VIX options settlement?
It is important to note that the VIX SOQ is the only
VIX calculation that uses traded prices. Every other reported VIX value
uses mid-quote prices of SPX option series. Typically, the theoretical
VIX bid/ask spread (i.e., the difference between VIX calculated using
bid prices and VIX calculated using ask prices) is 0.8 to 1.2 VIX
points. If the VIX SOQ is calculated using predominantly bid prices, or
predominantly ask prices, there may be a significant difference between
the exercise settlement value for VIX options and the reported VIX
values (based on mid-quote prices) on expiration day as well as at the
close on the day before expiration.
8. Why do VIX options prices appear different than other index option prices I'm used to seeing?
The price of any index option depends
on the forward price of the index and the expected shape of the forward
price distribution. In the case of stock indexes like the S&P 500,
the theoretical forward price is determined in a fairly straightforward
manner that considers the "cost-of-carry" (i.e., interest rates and
dividend yields). Forward prices of option volatility exhibit a "term
structure", meaning that the prices of options expiring on different
dates may imply different, albeit related, volatility estimates. VIX
option prices reflect the market's expectation of the VIX level at
expiration, as measured by the VIX SOQ on that date. For example,
prices for VIX options expiring in May 2006 reflect the expected
volatility implied in June 2006 SPX options; VIX options expiring in
August 2006 reflect the expected volatility implied in September 2006
SPX options, etc. The VIX volatility implied by June SPX options may be
significantly greater or lower than VIX volatility implied by September
SPX options.
Most readily available option pricing
models assume that price changes in an underlying asset - IBM or
S&P 500 Index (SPX), for example - have a lognormal distribution.
The distribution of VIX prices is not lognormal. In a lognormal world,
the price of IBM, for instance, could go to $0 per share, or rise to
very high levels depending on market conditions and company
fundamentals. A VIX value of zero, on the other hand, would imply a
market expectation of virtually no daily change in the level of
the S&P 500 Index! Extreme or persistently high VIX levels are just
as unlikely because there would need to be a market expectation of very
large daily SPX index changes over an extended period of time. Yet,
since 1990 the largest 1-day move in SPX has been -6.9%, and price
changes of at least ±5% have occurred only 8 times.
Option practitioners commonly refer to
the unique behavior of VIX and other volatility measures as
"mean-reverting," which is a statistical way of saying that at
historically low VIX levels, there is a higher probability that the
next big move will be up rather than down. Conversely, at historically
high VIX levels, the next big move is more likely to be down rather
than up.
Because of these differences between
VIX and traditional stock indexes, calculating exact theoretical values
for VIX options can be very complex. Assuming that VIX option prices
reflect the "term structure" and "mean reversion" characteristics of
VIX, VIX options could appear somewhat peculiar relative to other index
and individual stock options.
9. What is the "volatility of volatility"?
The expected volatility of VIX forward
prices is another important factor influencing VIX option prices. But
what is the "volatility of volatility"? It turns out that volatility,
as measured by spot VIX values, is indeed very volatile. As shown in
the following table, the volatility of the VIX Index was higher than
the volatility of the S&P 500 Index (SPX), the Nasdaq-100 Index
(NDX) and the Russell 2000 Index (RUT), and several stocks, including
Google, Apple and IBM.
Name 12/31/08
Price2008
VolatilityVIX 40.00 127.3% VX Near-Term Futures 41.94 88.9% SPX 903.25 41.0% NDX 1,211.65 42.3% RUT 499.45 46.4% GOOG 307.65 55.2% AAPL 85.35 58.2% GM 3.20 115.7% IBM 84.16 36.1% MSFT 19.44 48.5% C 6.71 116.8%
Name 12/31/09
Price2009
VolatilityVIX 21.68 88.9% VX Near-Term Futures 22.95 69.2% SPX 1,115.10 27.3% NDX 1,860.31 26.5% RUT 625.39 36.2% GOOG 619.98 30.1% AAPL 210.73 33.7% GLD 107.31 20.8% IBM 130.90 27.5% MSFT 30.48 37.3% MS 29.60 79.0%
Yet, there is another "volatility of
volatility" to consider. The underlying for VIX options, as noted
earlier, is the group SPX of options that will be used to calculate the
exercise settlement value at expiration; that is, forward VIX.
Historically, forward VIX has tended to be less volatile, on average,
than the VIX index itself. In recent years, for example, the volatility
of forward VIX (as measured by near-term VIX futures prices traded at
the CBOE Futures Exchange) was significantly less than the volatility
of the spot VIX. {2}
»
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Thanks for the post, Chopshop. The VIX products have been largely successful for the CBOE, and given the added attention to oil and gold over the past two years, matched with the "peak production" scenario for both, I expect traders to have a lot of fun with these new offerings.
As for the inclusion of corn and soybeans, shouldn't they simply have named these the Malthusian Volatility Indexes?
http://www.telegraph.co.uk/finance/personalfinance/investing/gold/737541...
GOLD, THE BEST PERFORMING ASSET FOR THE DECADE !
hey bates, whatcha gonna do when the biggest golden arms in the world grab ahold of you? ha ha ha
That is now. What is then?
GOLD BITCHES!!
I am Chumbawamba.