Nov 21, 2013

Nations VolDex (VOLI)

Nations VolDex is an alternative market volatility index. As everyone knows VIX product suite is a huge success and a big revenue generator for CBOE, which holds exclusive rights to the product. ISE has teamed up with Chicago-based NationsShares to launch VIX-like product and hopefully bring over some of that revenue to ISE.

How is VolDex different? VolDex is calculated from ATM options on SPY, while VIX is calculated from all options on SPX. Exact algorithm for VolDex is currently not disclosed (yes, I emailed and called the company). The basic overview can be found in SEC filing from ISE, but the document does not describe eactly how they calculate IV.

As one can plainly see the two indexes are not very different, the levels are quite correlated. VIX tends to run higher than VolDex.

The ratio (VIX/VolDex) is pretty much constant through the time, with average of 1.094 and median of 1.096, showing no significant skew.

The ratio does not appear to be related to the level, but difference (VIX-VolDex) shows linear relation to the VIX level. This (admittedly very simple) analysis leads me to suggest the simplest possible model: VolDex = 0.92 * VIX + noise. Of course, a more complicated model would be advised for trading, but this basic model has in-sample R^2 of 0.99.

Before I present my own analysis here are two articles from Risk, first introducing the VolDex, and second from CBOE providing a response on technical points, as well as CBOE's comment letter to SEC.

Vix challenged by new volatility index, by Yakob Peterseil (try this link, or this)
CBOE responds on Vix, by John Hiatt (link)
CBOE's comment letter to SEC (link)

In the Risk article Scott Nations is quoted saying "Because the spot Vix is impossible for traders to replicate, it becomes impossible for arbitrageurs to keep the levels of Vix futures consistent with the spot level of the Vix" I don't see that as valid argument, as I don't see how one can statically replicate VolDex futures. (Dynamic replication is possible, and I suspect it will be a practical nightmare)

CBOE argues (in the SEC comment) that VolDex is not a broad-based index, and can be easily manipulated. They provide an example that on the futures expiration day index will be calculated using only two front month SPY, and depending on where the spot is to the strike, most of the index value can come from a single option. I believe that the argument is theoretically valid, but I am having a difficulty figuring out how much the index could be manipulated in such way. If you have any thoughts on how to quantify this effect, send me an email.

On the other hand it is possible that the index would be more robust to manipulation: it does not use far otm puts that have disproportionate weight in the VIX. I wrote about this earlier in How to manipulate VIX settlement price. ATM options are most deep and liquid of any series, so manipulating them would be very expensive.

Overall, I think that both CBOE and ISE/Nations know that the indexes are not that much different from each other, and the arguments presented are of limited practical relevance. ISE also know that if they were to launch some volatility index that is really really different than VIX it will likely fail to attract any liquidity. I think the goal here is that VolDex will be similar enough to VIX that cross-hedging is possible, plus ISE will likely to provide substantial discounts on fees for the new product to attract market-makers.

At the time of writing VolDex options are pending SEC approval, and there is no mention of VolDex futures at all.

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