Short Volatility Trading With Volatility Derivatives

Short Volatility Tradingwith Volatility DerivativesRussell Rhoads, CFA

DisclosureOptions involve risk and are not suitable for all investors. Prior to buying or selling an option, a personmust receive a copy of Characteristics and Risks of Standardized Options. Copies are available fromyour broker or from The Options Clearing Corporation at www.theocc.com. Futures trading is notsuitable for all investors, and involves the risk of loss. The risk of loss in futures can be substantial. Youshould, therefore, carefully consider whether such trading is suitable for you in light of yourcircumstances and financial resources. For additional information regarding futures trading risks, seethe Risk Disclosure Statement set forth in CFTC Regulation §1.55(b). The information in thesematerials are provided for general education and information purposes only. No statement within thesematerials should be construed as a recommendation to buy or sell a security or future or to provideinvestment advice. Supporting documentation for any claims, comparisons, statistics or other technicaldata in these materials is available by contacting Cboe at www.cboe.com/Contact. Any strategiesdiscussed, including examples using actual securities and price data, are strictly for illustrative andeducational purposes only and are not to be construed as an endorsement, recommendation orsolicitation to buy or sell securities. In order to simplify the computations, commissions, fees, margininterest and taxes have not been included in the examples used in these materials. These costs willimpact the outcome of all stock and options transactions and must be considered prior to entering intoany transactions. Investors should consult their tax advisor as to how taxes affect the outcome ofcontemplated options transactions. Cboe , Cboe Volatility Index , and VIX are registeredtrademarks, and Cboe Global MarketsSM is a service mark of Cboe Exchange, Inc. S&P 500 is aregistered trademark of Standard and Poor's Financial Services, LLC, used under license. Financialproducts based on S&P indices are not sponsored, endorsed, sold or promoted by Standard & Poor’s,and neither Standard &Poor’s nor Cboe make any representation regarding the advisability of investingin such products. All other trademarks and service marks are the property of their respective owners. 2018 Cboe Exchange, Inc. All Rights Reserved.2

Short Volatility TradingCboe Volatility Index PrimerVIX FuturesVIX OptionsSummary / Contact3

Cboe Volatility IndexThe Cboe Volatility Index or the VIX Index is a consistent 30day measure of implied volatility as indicated by S&P 500 Indexoption pricesThe VIX Methodology is considered the industry standard for aconsistent measure of implied volatilityHistorically the VIX Index has displayed an inverse relationshipwith the S&P 500 which resulted in it being referred to as “thefear index”4

Cboe Volatility IndexVIX vs. S&P 500 Daily 2017270029260026S&P -17Mar-17Apr-17May-17Data Sources: Cboe Global Markets and 75

Cboe Volatility IndexVIX vs. SPX January 2018290020285018S&P /181/10/18Data Sources: Cboe Global Markets and 81/31/186

Cboe Volatility IndexVIX vs. SPX 2018 January and February 2018290038280032S&P 6/181/19/181/24/18Data Sources: Cboe Global Markets and 23/1882/28/187

VIX FuturesContract SpecificationsThe value of a VIX futures contracts is 1000 times the quotedvalueMinimum ticks are 0.05 ( 50) for single contract trades and 0.01( 10) for calendar spreadsThere are both standard and weekly contracts available fortrading – currently the majority of volume is concentrated in thestandard expirationsTrading is available almost 24 / 5 with small breaks after the endof regular US trading hoursExpirations typically occur on Wednesdays and the futures areAM settled8

VIX FuturesPricingUnlike many financial futures markets there is not a ‘fair value’relationship between VIX and the associated futures contractsAt times VIX futures are priced at a premium to spot VIX and attimes VIX futures will be priced at a discountThe pricing relationship is often referred to as being in contangoor backwardation9

VIX FuturesContango / BackwardationVIXMonth 1Month 2Month 3Month 4Month 5Month 6Month 7Month 8Month 910

VIX FuturesBackwardation – Impact of Brexit Referendum2624Friday 6:30 AM Chicago222018Thursday US Closing16VIXJul-16Aug-16Data Source: Cboe Global 1

VIX FuturesStandard Futures Daily Pricing28Dec Front Month24Dec 2015 VIX Future2016129/16Spot VIX10/7Data Source: www.Cboe.com10/2811/1812/1012

Trades into ExpirationTrading Example –August 14, 2014VIX @ 12.42Sell 1 August VIX @ 12.95August 19, 2014VIX @ 12.21Buy 1 August VIX @ 12.20Profit 0.7513

Trades into ExpirationTrading Example –August 14, 2014VIX @ 12.42Sell 1 August VIX @ 12.95Buy 1 September VIX @ 13.90August 19, 2014Buy 1 August VIX @ 12.20 ( 0.75)Sell 1 September VIX @ 13.50 (-0.40)Profit 0.3514

Trades into ExpirationTrading Example –January 10, 2018VIX @ 9.82Sell 1 January VIX @ 10.55January 16, 2018VIX @ 11.66Buy 1 January VIX @ 11.75Loss -1.2015

Trades into ExpirationTrading Example –January 10, 2018VIX @ 9.82Sell 1 January VIX @ 10.55Buy 1 February VIX @ 11.55January 16, 2018VIX @ 11.66Buy 1 January VIX @ 11.75Sell 1 February VIX @ 12.10Loss -0.6516

VIX OptionsVIX Index options are cash settled contracts that share anexpiration date with a VIX FutureTraders are better served using VIX Futures as the bestunderlying pricing vehicle for valuing VIX OptionsThis means that VIX Option positions are best priced off futuresbut settle in the spot indexThe multiplier for VIX Options is 100 and trading is availableduring both European and US market hours17

VIX OptionsFriday August 12, 2016 – VIX at 11.50 / Sep VIX Futures at 15.00Call Bid4.803.903.102.401.901.551.351.10Call 4151617Put Bid0.000.000.150.451.001.602.353.10Put Ask0.050.050.200.551.051.702.453.3018

VIX OptionsVIX at 11.50 / September VIX at 15.00Believe VIX Will Remain LowConsidering Buying a VIX PutPut Strike121314151617Ask Price0.200.551.051.702.453.30Break Even11.8012.4512.9513.3013.5513.70P/L VIX @ 11.500.300.951.451.802.052.2019

VIX OptionsBuy 1 VIX Sep 14 Put at 1.054.003.002.00VIX @11.50VXU6 @15.001.000.00111213141516171819-1.00-2.0020

VIX OptionsBear Call Spread #1March 23, 2016VIX @ 14.75May VIX @ 19.05Sell 1 May VIX 25 Call at 1.25Buy 1 VIX May 28 Call at 0.85Net Credit 0.4021

VIX OptionsBear Call Spread #12.001.00VIX @14.75VXK6 @19.050.001619222528-1.00-2.00-3.0022

VIX OptionsBear Call Spread #2March 23, 2016VIX @ 14.75May VIX @ 19.05Sell 1 May VIX 22 Call at 1.70Buy 1 VIX May 30 Call at 0.70Net Credit 1.0023

VIX OptionsBear Call Spread #26.003.00VIX @14.75VXK6 @19.050.0014161820222426283032-3.00-6.00-9.0024

Short Volatility TradingBoth VIX futures and options offer opportunities to short marketvolatilityRecent market action reminds us to have risk controls in placewhen taking a short volatility position25

Useful Links / Contact w.Cboe.com/blogsContact InformationRussell Rhoads, CFArhoads@Cboe.comTwitter - @RussellRhoads26

Short Volatility Trading with Volatility Derivatives. Russell Rhoads, CFA. 2. Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person . The multiplier for VIX Options is 100 and trading is available during both European and US market hours VIX Options