For January expiration my forecast is for 17.66 +/- 3.85 vs market forecast (based on futures and options implied volatility) of 19.80 +/- 4.53.
Week in Volatility
After a sharp decline last week, VIX traded in a 15.50-16.50 range, surprisingly rising on Thursday , which was the last trading day of the week. Given that many exchanges around the world will be closed tomorrow, and light trading around the New Year I expect the spot volatility indexes to remain low, while the term structure of futures to be high. This all should put some pressure on VXX, however I don't have a forecast. My forecast for the VIX to be in little higher in 16 - 17 range.
Week in Volatility
While stock and volatility indexes remained choppy most of the week, VIX took a beating on Friday, declining from already technical low of 17.50 to 16.00. I am sure that part of the decline is to be explained by lowered trading activity around holidays and non-trading days (VIX is calculated in calendar days, making it low biased) however that does not explain the whole story - for example VSTOXX that has similar calculation and holidays actually rose on Friday. So I will do some cross-asset comparison: GVZ - gold volatility also dropped on Friday to a new low, MOVE index that is tracking interest rate volatility is at 1-year high, JPMVXYG7 index that tracks implied volatility of G7 currency options is somewhere in between its 1-year high and low. My forecasts (and my trading positions) are for VIX to increase in price.
VIX Falls
As I'm writing this VIX is trading at ~15.60, very close to it annual low of 15.23 back in April. This level is obviously significantly below what I expect a month ago, but also lower than investor expectations. The front month futures expiring on Wed, Dec 22 that have only 2 full trading days until expiration are still relatively juicy at 17.30! Of course the big question on everyone's mind is what is next for the market and for the VIX. While the future is uncertain, I think that VIX has entered a low-volatility regime (see my post here). I think economic uncertainty will not allow long-term VIX futures to fall much lower (back months are about 25) , which means that term structure premium is likely to remain high. If I'm correct in my hypothesis, we can see a steady decline in VXX due to increased rolling costs. Good luck traders, hope everyone has a good expiration!
VSXX Disappoints European Investors
I have written before about VSXX - an ETF that tracks pan-european VSTOXX volatility index, European equivalent of VXX. In that post I described how VSXX performance may be different, because of the flatter term structure of VSTOXX volatility futures, that will translate into lower rolling costs, and better performance for VSXX investors, at least compared with VXX. I also noted that traders may take advantage of this difference in a relative value trade. When I wrote the post, VSXX was trading for only two months, however now after seven month of trading it is becoming clear that my investment hypothesis not deliver, and VSTOXX futures markets became more economically efficient.
Here's the chart of what happened: VSXX originally listed at around the same Euro value as the index, however in the last few weeks VSXX is about 70% of VSTOXX index.
If you looked at the relative plots of VIX and VSTOXX with their futures indexes (on which ETFs are based) it is clear that historically VSTOXX futures index did much better job in tracking index levels than the VIX futures index. To understand the dynamics, I have performed the following two regressions:
return on SPVIXSTR ~ α + β * return on VIX, and
return on VST1MT ~ α + β * return on VSTOXX.
Using the data for the last five years, in the first case α = -0.0016174 (t=-3.2335) α * 252 = -40% per year negative "premium" for the VIX futures index. In the second case α = -0.00021095 (t= -0.30876, intercept not statistically significant) α * 252 = -5% per year negative "premium" for the VSTOXX futures index.
However when I used data for the last half year - approximately since VSXX came into existence, intercept values became much closer to each other, at -0.006422 -0.0047229 for VIX and VSTOXX respectively. These numbers by themselves imply a very negative risk premium, they are at least the same order of magnitude, as opposed to alphas from the 5-year regressions.
It seems that there is an equal demand now in Europe for volatility protection, which brought returns on the futures indexes in line with each other. In fact VSXX and VXX followed very similar paths (normalized returns in local currencies)
In conclusion: what was hoped to be a unique investment opportunity for European investors seized to exist. Once a trading instrument is in the market traders work quickly to make profits and eliminate inefficiencies.
Here's the chart of what happened: VSXX originally listed at around the same Euro value as the index, however in the last few weeks VSXX is about 70% of VSTOXX index.
If you looked at the relative plots of VIX and VSTOXX with their futures indexes (on which ETFs are based) it is clear that historically VSTOXX futures index did much better job in tracking index levels than the VIX futures index. To understand the dynamics, I have performed the following two regressions:
return on SPVIXSTR ~ α + β * return on VIX, and
return on VST1MT ~ α + β * return on VSTOXX.
Using the data for the last five years, in the first case α = -0.0016174 (t=-3.2335) α * 252 = -40% per year negative "premium" for the VIX futures index. In the second case α = -0.00021095 (t= -0.30876, intercept not statistically significant) α * 252 = -5% per year negative "premium" for the VSTOXX futures index.
However when I used data for the last half year - approximately since VSXX came into existence, intercept values became much closer to each other, at -0.006422 -0.0047229 for VIX and VSTOXX respectively. These numbers by themselves imply a very negative risk premium, they are at least the same order of magnitude, as opposed to alphas from the 5-year regressions.
It seems that there is an equal demand now in Europe for volatility protection, which brought returns on the futures indexes in line with each other. In fact VSXX and VXX followed very similar paths (normalized returns in local currencies)
Russian Volatility Index
It is official, yesterday RTS announced (eng, rus) that they will start disseminating the first "official" volatility index based on the Russian options market.
I blogged earlier about Russian VIX here, however at this time ОТКРЫТИЕ removed previous links to the construction of the volatility index, and I could not find any details on the RTS website. I assume that either way the exact methodology will feature two modifications to the VIX algorithm, namely parametric interpolation of the volatility skew to deal with relatively small liquidity in the market, and nonlinear weighting of the months, because expirations are sparse, and do not always bracket 30-day maturity.
RTS stated that they will start disseminating the index on Dec 7th. Bloomberg ticker for the index is RTSVX.
I blogged earlier about Russian VIX here, however at this time ОТКРЫТИЕ removed previous links to the construction of the volatility index, and I could not find any details on the RTS website. I assume that either way the exact methodology will feature two modifications to the VIX algorithm, namely parametric interpolation of the volatility skew to deal with relatively small liquidity in the market, and nonlinear weighting of the months, because expirations are sparse, and do not always bracket 30-day maturity.
RTS stated that they will start disseminating the index on Dec 7th. Bloomberg ticker for the index is RTSVX.
Commodity Volatility Indexes
One of the most exciting recent developments in volatility space was the launch of two commodity volatility indexes on CME - one based on NYMEX Crude Oil contract, and another on COMEX Gold. While there has been no volume in these products, I hope that will change when CME will list options before the end of the year. Meanwhile I started researching existing commodity volatility indexes. In the summer of 2008 CBOE launched two indexes: OVX based on USO options and GVZ based on GLD options, both using the same methodology as the VIX. In the October of this year, CME and CBOE announced creation of another two parallel indexes on crude oil and gold volatility, but based on CME contracts. Also Johannesburg Stock Exchange calculates SAVI White Maize - a 3 months volatility index for white maize, which (to a city person like myself) is some type of corn. Exchange summary is available here. At this point I believe these three are the only commodity products that have volatility indexes. If you know of any others, please send me an email. Since now there are many more indexes available for comparison, I decided to draw some charts. Below is the overlapping history of OVX index (based on USO) and OIV (based on CL) . As you can see that two indexes are comparable. What is interesting (and I have double-checked the data) is that it appears that OVX was leading OIV for about a year in the plot, until late 2009. In the past 12 months the apparent lead disappears, and indexes move more or less in tandem. Again, let me emphasize that I have not performed statistical tests to determine any lead / lag relationship; the statements above are based purely on eyeballing the charts. 
Oil volatility seems to be only slightly related to equity vol, which makes sense since the two are driven by different fundamentals. 
Gold volatility however, driven by dollar / inflation risks, does track VIX more closely. 
I could not obtain historical data for GVX index from CME website, but would like to conduct a more thorough analysis of gold-equity volatility once data becomes available. See more commodity volatility indexes here.
Oil volatility seems to be only slightly related to equity vol, which makes sense since the two are driven by different fundamentals. 
Gold volatility however, driven by dollar / inflation risks, does track VIX more closely. 
I could not obtain historical data for GVX index from CME website, but would like to conduct a more thorough analysis of gold-equity volatility once data becomes available. See more commodity volatility indexes here.
VIX Forecast
VIX settled Wednesday morning at 22.21, up 0.80 from last expiration, but it was a wild ride! My biggest bet for the past expiration was for VIX to finish below 20, which was working out fine for me right before last Friday. I finally got my code in place and ran expiration plots for december: the expected value for the VIX 20.57 with volatility (in $, not %) of 5.26. Also, I included probabilities of VIX expiring at a particular range. For the trading purposes it seems that the market is ambivalent between low-volatility regime and middle-volatility regime, and honestly I don't have a good gameplan yet. Good luck, traders, and hedge your deltas!
22-DEC-2010 probability of VIX from 10 to 15 is 4%
22-DEC-2010 probability of VIX from 15 to 20 is 54%
22-DEC-2010 probability of VIX from 20 to 25 is 30%
22-DEC-2010 probability of VIX from 25 to 30 is 7%
22-DEC-2010 probability of VIX from 30 to 35 is 3%
22-DEC-2010 probability of VIX from 35 to 40 is 1%
22-DEC-2010 probability of VIX from 40 to 45 is 1%
22-DEC-2010 probability of VIX from 45 to 50 is 1%
22-DEC-2010 probability of VIX from 50 to 55 is 0%
22-DEC-2010 probability of VIX from 55 to 60 is 0%
22-DEC-2010 probability of VIX from 60 to 65 is 0%
22-DEC-2010 probability of VIX from 65 to 70 is 0%
22-DEC-2010 probability of VIX from 70 to 75 is 0%
More VIX stuff from Jeremy Wien
I already wrote here about 2 most excellent presentations Jeremy Wien did on the VIX, but earlier today I found (googling) another article that I have never read before where he gives rules for trading VIX and VIX options.
1. There's a lot of "air" once we move out of the perceived range of the VIX
2. The rules of market liquidity in crises apply to VIX ten-fold
3. Never sell a VIX call below .25 unless it is protected by something
4. You must manage your VIX positions at least semi-actively (even/especially the ones that are in place as hedges)
5. For true CRASH protection, there is not a better product to own than a low-delta VIX call
While not as detailed as his other 2 articles, there is a lot of helpful advice. Enjoy!
1. There's a lot of "air" once we move out of the perceived range of the VIX
2. The rules of market liquidity in crises apply to VIX ten-fold
3. Never sell a VIX call below .25 unless it is protected by something
4. You must manage your VIX positions at least semi-actively (even/especially the ones that are in place as hedges)
5. For true CRASH protection, there is not a better product to own than a low-delta VIX call
While not as detailed as his other 2 articles, there is a lot of helpful advice. Enjoy!
Week in Volatility
S&P and Eurostoxx fell about 2% this week, however Friday's action really pushed VIX futures higher. VSTOXX futures ended the week only slightly higher - mostly because of the time difference having closed on Friday while VIX continued to rise, and I fully expect VSTOXX futures to open lower on Monday (by about a point) to make up the difference.
Overall this week's action surprised me. I was positioning my portfolio to profit from further fall in the VIX, where my max profit zone is from about 18 to 20 in the front month, however given Friday action (VIX high at > 21) with just 2 full trading days to go before expiration seems like a very uncertain proposition.
While I thought that the market decided that it is the time for low volatility regime, we're still probably in the mid vol levels - and can easily see VIX push higher given a catalyst.
Overall this week's action surprised me. I was positioning my portfolio to profit from further fall in the VIX, where my max profit zone is from about 18 to 20 in the front month, however given Friday action (VIX high at > 21) with just 2 full trading days to go before expiration seems like a very uncertain proposition.
While I thought that the market decided that it is the time for low volatility regime, we're still probably in the mid vol levels - and can easily see VIX push higher given a catalyst.
Canadian VIX - VIXC
Few weeks ago Montreal Exchange changed the methodology of its volatility index. The old index, MVX was constructed in the same way as the VXO - using implied volatility of ATM options, while the new index VIXC (Bloomberg symbol VIXC:IND) uses the same methodology as the VIX. Here is a presentation on the index construction. Unfortunately the old index was completely discontinued, while the new index has only one year of history. For my research purposes I combined the two, averaging closing values on the overlapping period. Exchange data here, and you can download the combined data here.
Below is the chart of the combined history MVX-VIXC vs VIX.
Below is the chart of the combined history MVX-VIXC vs VIX.
Confused by VIX / SPX correlation? You are not the only one!
This morning I came across this gem on FT blog. Based on her statistical and technical analysis (see the chart attached to the post) the author writes that recently correlation between SPX and VIX has been positive, and predicts that it needs to return to the norm. The problem is that the author has got it all wrong, confusing price correlation and return correlation.
If we look at some short time periods, it is not unusual to observe VIX prices to look like a mirror image of SPX prices, just like in the chart on FT website. This pattern however is not robust - if we look at a scatterplot of SPX prices vs VIX prices over the last 20 years, it is clear that there is no correlation. It is also intuitive - S&P moves around all over the place, while VIX stays most of the time in a range.
Where correlation is robust is in returns - percent changes (daily, weekly, etc.) The scatterplot of daily returns for the last 20 years clearly shows strong negative correlation (-0.69) in the data.
2 - need more than 8 days of data to create reliable statistics.
If we look at some short time periods, it is not unusual to observe VIX prices to look like a mirror image of SPX prices, just like in the chart on FT website. This pattern however is not robust - if we look at a scatterplot of SPX prices vs VIX prices over the last 20 years, it is clear that there is no correlation. It is also intuitive - S&P moves around all over the place, while VIX stays most of the time in a range.
Where correlation is robust is in returns - percent changes (daily, weekly, etc.) The scatterplot of daily returns for the last 20 years clearly shows strong negative correlation (-0.69) in the data.
The same pattern exists for weekly and monthly returns (I created the plots using non-overlapping returns)
From what I see in the data any correlation between SPX and VIX price levels is mostly spurious and coincidental.
What is equally puzzling is the authors' claim that correlation turned positive since October 22nd of this year. There's been only 8 trading days, and hardly any statistic should be calculated on only 8 observations, especially such a "noisy" one as correlation. Even if I were to agree with Ms Brooks methodology, the correlation observed is 0.35 +/- 0.37 (MSE using 10K bootstrap simulations) i.e. the real correlation cannot be reliably estimated based on such a short sample. The last plot is the histogram of correlation coefficient.
Two points in conclusion:
1 - there is no stable correlation between SPX and VIX price levels, but there is a stable robust correlation between SPX returns and VIX returns on different time horizons.
MOVE Index, Part 2
My last post was about predicting VIX index using MOVE index where I posted a basic model for VIX fair value. MOVE closed last week at 99.80 (Bloomberg) , implying VIX price of 20.98. Of course to use the model one needs to investigate the average error. To do that I used 10K bootstrap regressions to figure out mean absolute error of 4.72(histogram below). While not amazingly accurate, VIX fair value model is good enough as a basic cheap/expensive indicator. Since the current VIX value is well within the error of the forecast, it is clear that equity implied volatility is in line with the Treasury markets.
MOVE Index and VIX Index
MOVE index was developed by Merrill Lynch to measure implied volatility of US Treasury markets. It is a yield-curve weighted average of normalized implied volatility of 30-day options. The index has been in existence for several years now, however it is seldom discussed, either in itself, or in relationship to the VIX. What I am interested in is if volatility in the treasury market can forecast volatility in the equities.
The images above show the MOVE and VIX indexes for the last 5 years, and ratio=VIX/MOVE. While it appears from the plot that MOVE started increasing much earlier in apparent anticipation of 2008, corresponding to low points in the ratio plot, subsequent rise in the VIX was much more severe than that of the MOVE.
To get a better view of the relationship between the two indexes I conducted a number of regression-based tests. The results all indicate that indeed MOVE index can help predict future level VIX. The simplest model for the VIX level based on the MOVE is
VIX = EXP(-1.84+1.06*LN(MOVE))
You can type the formula directly into Excel. MOVE index closed yesterday at 98.70, implying VIX price of 20.65, compared to the last VIX price of 20.88.
The images above show the MOVE and VIX indexes for the last 5 years, and ratio=VIX/MOVE. While it appears from the plot that MOVE started increasing much earlier in apparent anticipation of 2008, corresponding to low points in the ratio plot, subsequent rise in the VIX was much more severe than that of the MOVE.
To get a better view of the relationship between the two indexes I conducted a number of regression-based tests. The results all indicate that indeed MOVE index can help predict future level VIX. The simplest model for the VIX level based on the MOVE is
VIX = EXP(-1.84+1.06*LN(MOVE))
You can type the formula directly into Excel. MOVE index closed yesterday at 98.70, implying VIX price of 20.65, compared to the last VIX price of 20.88.
Week in volatility, VIX forecast analysis
Equity indexes traded in a range this week, ending almost unchanged / slightly up over week. However VIX futures fell strongly across the board, declining an average 1.76 points, which VSTOXX futures fell 1.05 points. The sharpest decline was in Nov VIX futures (current front month, following October expiration 5 days ago) that feel almost 3 points from 24.05 to 21.10.
Despite this sharp decline I continue making bearish bets. It is true that we are in a low volatility regime, but my own research indicates that such low-volatility regimes are usually persistent, and provide a good opportunities for selling volatility. I plan to write more about this when I have more time.
October futures and options expired last Wednesday, settling at 21.41 . My forecast made last month for October expiration was 22.62 (error=1.21) vs market forecast 25.55 (error=4.14). I do not have yet forecast for Nov expiration, because of some software issues, however I plan to update the blog as soon as I have them.
Good luck traders, and hedge your deltas!
Despite this sharp decline I continue making bearish bets. It is true that we are in a low volatility regime, but my own research indicates that such low-volatility regimes are usually persistent, and provide a good opportunities for selling volatility. I plan to write more about this when I have more time.
October futures and options expired last Wednesday, settling at 21.41 . My forecast made last month for October expiration was 22.62 (error=1.21) vs market forecast 25.55 (error=4.14). I do not have yet forecast for Nov expiration, because of some software issues, however I plan to update the blog as soon as I have them.
Good luck traders, and hedge your deltas!
STLFSI and VIX
First off, let me apologize to all my readers for infrequent posting. I was very busy moving to NYC and just did not have the time to follow up on all the news in the volatility universe or questions that you emailed me. Also, I would like to thank my friend Ethan for all his help.
Last week vixandmore wrote two excellent posts about stress indexes, namely St. Louis Fed Financial Stress Index and Kansas City Financial Stress Index, here and here. I previously mentioned STLFSI and its relationship with VIX here.
I don't have any criticism for the indexes, however I think that practically they are useless - STLFSI is published weekly with at least one week lag (right now the latest release is dated 9/24/2010), and KCFSI is published once per month. If you're trading, such delays are simply impractical, and reconstructing indexes from raw data to create daily values seems like a lot of work.
Good luck traders, and hedge your deltas!
Last week vixandmore wrote two excellent posts about stress indexes, namely St. Louis Fed Financial Stress Index and Kansas City Financial Stress Index, here and here. I previously mentioned STLFSI and its relationship with VIX here.
I don't have any criticism for the indexes, however I think that practically they are useless - STLFSI is published weekly with at least one week lag (right now the latest release is dated 9/24/2010), and KCFSI is published once per month. If you're trading, such delays are simply impractical, and reconstructing indexes from raw data to create daily values seems like a lot of work.
Good luck traders, and hedge your deltas!
Week in Volatility
Beside market weakness on Wednesday and Thursday volatility indexes remain almost unchanged for the week. We're only few trading days away from October, but futures and skew in vol options remain cheap. The 22.5/25/27.5 fly I put on a while ago is not working well - even though the futures approached the sweet spot, marks have barely moved - probably because of the skew. Now I'm trying to roll the fly somewhere lower.
I am still on vacation, so there probably will be no other posts this week.
I am still on vacation, so there probably will be no other posts this week.
Crude Oil & Gold Volatility Futures to Trade on CME
After announcing new commodity volatility indexes back in March, CME announced they're actually launching futures and options on NYMEX WTI and COMEX Gold volatility in the fourth quarter. This is to be followed by launching volatility derivatives on Soybeans and Corn in the first quarter of next year.
There is no exact schedule of product launch - whether CME will launch futures first, and then introduce options, or launch futures and option simultaneously. I hope that the new products will succeed, although I have my reservation given many failures in volatility derivatives. What makes these contracts different is that GVX and OIV would be the first commodity volatility derivatives to be listed.
CME product webpage here, including historical data for all new indexes. Press release here.
There is no exact schedule of product launch - whether CME will launch futures first, and then introduce options, or launch futures and option simultaneously. I hope that the new products will succeed, although I have my reservation given many failures in volatility derivatives. What makes these contracts different is that GVX and OIV would be the first commodity volatility derivatives to be listed.
CME product webpage here, including historical data for all new indexes. Press release here.
Australian Volatility Index S&P/ASX 200 VIX
"The S&P/ASX 200 VIX will be an end-of-day index that reflects investor sentiment about the expected volatility in the Australian benchmark equity index, the S&P/ASX 200." The exchange will start disseminating the index (ticker XVI) on Sep 23, 2010. The index follows the same methodology as the VIX.
Exchange page on the index here, including historical data for the new index . Press release here.
Exchange page on the index here, including historical data for the new index . Press release here.
P.S. Bloomberg symbol for S&P/ASX 200 VIX is SPAVIX.
VIX as a Commodity
There is an excellent article on commodities modelling that limns many of common features between VIX derivatives and commodity derivatives:
VIX - underlying not tradable / not possible to practically replicate
Commodities - all liquidity in the forwards, not spot
VIX - no pure arbitrage plays between different months
Commodities - limited arbitrage opportunities depending on storage
VIX, Commodities - stable long maturities, volatile near maturities
VIX, Commodities - volatility is backwardated
VIX - underlying not tradable / not possible to practically replicate
Commodities - all liquidity in the forwards, not spot
VIX - no pure arbitrage plays between different months
Commodities - limited arbitrage opportunities depending on storage
VIX, Commodities - stable long maturities, volatile near maturities
VIX, Commodities - volatility is backwardated
VIX - call skew, dominated by consumers
Commodities - call skew in products like NG
VIX, Commodities - spiking behavior, difficult to model with markovian models, requires extreme mean-reversion (much greater than in historical data), or regime switching (VIX seem to be well-partitioned into 3 regimes)
VIX Expiration, Interesting Action in VIX Binaries
$VRO printed at 22.97 - vs my forecast of 24.97, and market forecast of 29.44, here. September was a tricky month to trade - the swings in the beginning of the month, and rapid decline of VIX/VIX Futures made for a lot of excitement, but I had my best month in terms of PL. My forecast for October expiration (in 34 calendar days) is 22.62 with standard deviation of 5.18. Market forecast this morning is 25.55 with std of 6.19. I'm still trying to figure out my game plan for October - the sweet spot is at 25, significantly above my forecast, but about on par with the futures. On the other hand if volatility picks up (and there's plenty of time and fundamental weakness for it to do so) 25 VIX may seem low.
There was some interesting action on Tuesday in Binary VIX Options: Sep 20 Puts were (suddenly?) bid up. I saw bid at 0.07, to 0.10 200 contracts, which is big for binaries. VIX made a brief dip below 20 that day, but given there were just few hours to go these options seemed hugely expensive. VIX closed at 21.56 and puts close at 0.05 bid. My boss said that perhaps someone was taking profit, as there was 200+ open interest on the puts, however I don't think that was the case. I don't have historical data for options, however knowing VIX history I am pretty sure that that was the highest price for the contract.
There was some interesting action on Tuesday in Binary VIX Options: Sep 20 Puts were (suddenly?) bid up. I saw bid at 0.07, to 0.10 200 contracts, which is big for binaries. VIX made a brief dip below 20 that day, but given there were just few hours to go these options seemed hugely expensive. VIX closed at 21.56 and puts close at 0.05 bid. My boss said that perhaps someone was taking profit, as there was 200+ open interest on the puts, however I don't think that was the case. I don't have historical data for options, however knowing VIX history I am pretty sure that that was the highest price for the contract.
Week in Volatility
This has been a short (US holiday) and rather boring week for volatility. VIX was practically unchanged, with futures falling slightly. VSTOXX was unchanged, however futures fell sharply with front three months declining by about 2 points, and bank months by about half point.
With front month futures risk premium decaying rapidly into expiration, and with my sweet spot at about 25 I had trouble re-hedging, and trying to shift everything lower. With only two trading days until expiration it is a fait accompli that September won't work out exactly as I planned. October futures closed at 27, and with October historically being a volatile month, October skew seems cheap. Is there a way to be short delta and long skew?
Weekly VIX Options
According to the Bloomberg report CBOE will start trading weekly options on the VIX. I was very excited about the news until I found the details on CBOE website here:
- The options will trade on CFE, not CBOE
- The options are American-style, exercised into near-term futures
- Expire on Fridays, not Wednesdays
Volatility Cones, Support/Resistance for VIX Futures
These are maximum, average, and minimum values for VIX futures as a function of days until expiration. The left-most values are the values that correspond to expiration settlement values (VRO) , and the right-most are historical values of futures that expire in about six months.
The plot does not convey all the available data. Here is a different plot that is derived from the same dataset.
Black lines are like error bars - representing highest and lowest values of VIX futures. The red band inside is the middle 50% of the data, i.e. form first to third quartile. Since VIX futures were listed most of the trading action took place somewhere between 15 and 30. Most of the lower quartile action happened in 2004-2006, and most of the upper quartile happened in 2008.
With longer term VIX futures trading at over 30, and recent realized volatility at about 20% I think the futures will come down a bit to I personally have bearish bets in January - although the reason for trade was based on my forecasting model, and not on the analysis above.
Now here comes what I think is the most interesting part: same plot, now every historical futures value is a dot.
The VIX futures can be partitioned into three regimes. If that is not clear from previous plot - here is a histogram.
These three regimes are not present in the VIX index data, they are only seen in VIX futures. Using k-means of log values the centers are:
The plot does not convey all the available data. Here is a different plot that is derived from the same dataset.
Black lines are like error bars - representing highest and lowest values of VIX futures. The red band inside is the middle 50% of the data, i.e. form first to third quartile. Since VIX futures were listed most of the trading action took place somewhere between 15 and 30. Most of the lower quartile action happened in 2004-2006, and most of the upper quartile happened in 2008.
With longer term VIX futures trading at over 30, and recent realized volatility at about 20% I think the futures will come down a bit to I personally have bearish bets in January - although the reason for trade was based on my forecasting model, and not on the analysis above.
Now here comes what I think is the most interesting part: same plot, now every historical futures value is a dot.
The VIX futures can be partitioned into three regimes. If that is not clear from previous plot - here is a histogram.
These three regimes are not present in the VIX index data, they are only seen in VIX futures. Using k-means of log values the centers are:
- Low 14.55 +/- 1.60
- Middle 24.31 +/- 2.83
- High 37.19 +/- 6.45
Timeline of Listed Volatility Futures
Update: The timeline has last been updated on Jan 15th, 2013
Right now there are only two indexes with listed volatility instruments - VIX and VSTOXX. There are talks, mainly press-releases from different exchanges about plans to list futures on local vol indexes (VKOSPI futures, India VIX futures, Australian VIX futures,Japanese VIX futures), however I think we're a very long way from seeing another successful volatility instrument. The reason is that historically there just has not been enough interest from traders - just look at this timeline of volatility futures:
Right now there are only two indexes with listed volatility instruments - VIX and VSTOXX. There are talks, mainly press-releases from different exchanges about plans to list futures on local vol indexes (VKOSPI futures, India VIX futures, Australian VIX futures,
- Jan 1998 DTB lists VOLAX futures on DAX
- Dec 1998 DTB delists VOLAX futures on DAX
- Mar 2004 CBOE lists futures on VIX
- Apr 2005 CBOE lists DJIA volatility futures
- Sep 2005 Eurex lists futures on VDAX, VSMI, and VSTOXX
- Feb 2006 CBOE lists VIX options
- Jul 2007 CBOE lists Nasdaq and Russell 2000 volatility futures
- Mar 2009 CBOE lists mini-VIX futures
- Jun 2009 Eurex lists MINI-VSTOXX futures
- Jul 2009 Eurex delists VDAX, VSTOXX, VSMI futures
- Aug 2009 CBOE delists DJIA volatility futures
- Feb 2009 CBOE delists Nasdaq volatility futures
- Feb 2010 CBOE delists Russell 2000 volatility futures
- Mar 2010 Eurex lists options on VSTOXX
- Mar 2011 CBOE lists futures on GVZ (Gold)
- Mar 2011 CBOE lists options on GVZ (Gold)
- Jun 2011 RTS lists futures on RTSVX
- Jan 2012 CBOE lists futures and options on VXEEM (Emerging Markets)
- Feb 2012 CBOE lists futures VXEW (Brazil)
- Mar 2012 CBOE lists options on VXEW (Brazil) and futures on OVX (Oil)
- Apr 2012 CBOE lists options on OVX (Oil)
- Feb 2012 HKFE lists futures on VHSI
- Feb 2012 Osaka lists futures on VNKY
Week in Volatility
It was a bumpy ride for the VIX (and my portfolio) this week. The index rose above 28 on Tue and Wed, and fell below 25 on Fri. The week to week change in the equity and volatility indexes was completely overshadowed by intraweek action. VIX and VSTOXX futures declined in the near term, however the long-term levels were unchanged. With volatility rising and falling so much in one week, it seems to be a good time to rethink the forecasts. My model still shows Sep expiration forecast of 25.36 (higher than my previous forecast) with volatility of 3.85 (lower than my previous forecast).
Simple Trick to Convert Volatility
As I am sure all of you know Russia has began a full scale war against my home country Ukraine. Please make no mistake - Putin's goal in not to stop the expansion of NATO, not to install puppet government, and certainly not to bring peace. The goal is genocide of Ukrainian people.
When Ukraine was under Russian communist occupation,
Russians started off with killing of political leaders, repression of
Ukrainian language and traditions - including prohibiting people from
celebrating Christmas, and then wide-scale murder of millions of
Ukrainian civilians. We already starting to see this today: Russians are targeting
civilian hospitals, kindergartens, and bomb shelters.
If you are reading this make a phone call
to your government representatives and ask to sanction Russian
federation in absolutely any way possible, and provide military aid to Ukraine. Please just do this little thing to give us a
chance to protect ourselves.
My boss came to me today with "how do I convert this monthly vol to annual?". This is by far not the first time someone asked me to convert x-period volatility to y-period volatility. If you're having trouble doing this, here is a simple trick to remember: figure out the multiplier as if scaling was linear, and take the square root of that multiplier. For example, returns scale linearly with time. If someone gives you a monthly returns to convert to annual, you would simply multiply it by 12. So, in the case of converting monthly volatility to annual, multiply it by √12. If someone gives you annual returns and asks you to calculate daily returns you would divide it by 252. To convert annual volatility to daily volatility divide it by √252.
P.S. √252≈16, which is the reason for "rule of 16" for converting daily to annual volatility.
P.P.S. To convert:
P.P.S. To convert:
| Daily to weekly | -> | multiply by √5 |
| Daily to monthly | -> | multiply by √21 |
| Daily to quarterly | -> | multiply by √63 |
| Daily to annual | -> | multiply by √252 |
| Weekly to daily | -> | divide by √5 |
| Weekly to monthly | -> | multiply by √4 |
| Weekly to quarterly | -> | multiply by √12.5 |
| Weekly to annual | -> | multiply by √50 |
| Monthly to daily | -> | divide by √21 |
| Monthly to weekly | -> | divide by √4 |
| Monthly to quarterly | -> | multiply by √3 |
| Monthly to annual | -> | multiply by √12 |
| Quarterly to daily | -> | divide by √63 |
| Quarterly to weekly | -> | divide by √12.5 |
| Quarterly to monthly | -> | divide by √3 |
| Quarterly to annual | -> | multiply by √4 |
| Annual to daily | -> | divide by √252 |
| Annual to weekly | -> | divide by √50 |
| Annual to monthly | -> | divide by √12 |
| Annual to quarterly | -> | divide by √4 |
VIX Trading Strategies from Jeremy Wien
Mr Wien published two excellent articles on VIX strategies. Here is the presentation he did for CBOE last April, and here is an article he wrote for Active Trader magazine, published this May.
The strategies he recommends:
The strategies he recommends:
- Short straddle + hedge upside risk with OTM call
- 1x2 put spread
- Butterfly
- Bull spread + long call
Week in Volatility, Forecasts Review
This was a mixed week for volatility - the short term vol was all over the place, although mostly higher. Long-term vol was definitely on the upswing - the long-term futures being up about a third of a point. VSTOXX futures mostly rose, moving an average of 0.13 points. Overall volatility indexes around the world were down half of a point.
1 Prediction: volatility 2% per day, realized: 1.8% Implied volatility on indexes is usually higher than realized, but this month the difference is not huge. It is not unusual to see all implied risk measures to be higher than the realized.
2. Prediction: daily range $2, realized: $1.48.
3. Prediction: monthly range $10.42, realized: $7.13. Monthly high prediction: $69.19, realized: $67.27. Monthly low prediction: $58.77, realized: $60.14.
4. Maximum drawdown: $8.34, realized: $7.13.
Do these finding mean that the formulas are accurate enough to be used for trading decisions and quick assessment of risk? I think after applying proper implied/historical adjustment the formulas are very helpful, and that is how I use them in my own trading.
VIX Expiration
$VRO settled at 24.82, only 2 cents away from my last-month forecast of 24.80, here. Although I wish I could attribute such amazing accuracy to my forecasting skills, luck has played a significant factor. My forecast for September is 24.97 with standard deviation of 5.45, vs market's forecast of 29.44 with standard deviation of 7.45. I have a lot of concern regarding skew trades into Sep, and especially Oct expirations, so plan to proceed more cautiously. Good luck traders, and hedge your deltas!
AlphaShares China Volatility Index
There is a (relatively) new volatility index, that I think does not get as much attention as it should - the AlphaShares China Volatility Index, ASCNCHIX, or CHIX. I won't pretend to be an economist, but Chinese volatility is an important factor to consider for all traders and investors. The index is also interesting because it is actually composed of two underlying indexes.
The description on Bloomberg website here is actually somewhat misleading: "The AlphaShares Chinese Volatility Index measures the implied volatility of options on the FTSE Xinhua China 25 and Hang Seng (HSI) indices." In a private email Alphashares representative explained that the index is an equal-weighted average of ATM volatilities of FXI ETF (US) and HSI (HK) .
Over the last five years VIX and CHIX moved in tandem, with CHIX about 1.5 times the VIX. However in the last 3 months this ratio fell below 1, with CHIX trading below VIX.
The description on Bloomberg website here is actually somewhat misleading: "The AlphaShares Chinese Volatility Index measures the implied volatility of options on the FTSE Xinhua China 25 and Hang Seng (HSI) indices." In a private email Alphashares representative explained that the index is an equal-weighted average of ATM volatilities of FXI ETF (US) and HSI (HK) .
Over the last five years VIX and CHIX moved in tandem, with CHIX about 1.5 times the VIX. However in the last 3 months this ratio fell below 1, with CHIX trading below VIX.
Week in Volatility
Markets fell this week, with S&P down almost 4% and STOXX falling 2.5%. VIX rose 4.5 points; Jan-11 up 2.1 points, Feb-11 up 1.7 points. The rise in long-term vol occurred overnight from Tue to Wed. STOXX did not fall as much as S&P, and rise in VSTOXX was also less pronounced - index up 2.26, and long-term futures up 1+ point.
What is really interesting is that while VIX and VSTOXX rose this week, other volatility indexes around the world fell. I did not have the time for thorough data analysis, but NSE India VIX index made an all-time low, closing at 16.74 on Fri, link. Keep in mind that the index was in existence for a relatively short time. I was able to put together two charts of Citi Asian volatility indexes (that have longer history than India VIX) and VIX.
Over the past five years most of Asian markets had higher implied volatility than the VIX.
What is really interesting is that while VIX and VSTOXX rose this week, other volatility indexes around the world fell. I did not have the time for thorough data analysis, but NSE India VIX index made an all-time low, closing at 16.74 on Fri, link. Keep in mind that the index was in existence for a relatively short time. I was able to put together two charts of Citi Asian volatility indexes (that have longer history than India VIX) and VIX.
Over the past five years most of Asian markets had higher implied volatility than the VIX.
Understanding VIX Futures Movement, Part 3
Part 1 here, part 2 here. In the previous post I described decorrelation of VIX futures over time. In this post I will discuss the the decay, or theta of futures.
Surlytrader writes "Consider this the cost of holding the long position over time. This is important because we can think about VIX futures trades much like we think about calendar spreads in the options world. In a calendar spread you buy a longer dated option and sell a short dated option. You hope that the short-dated option decays (loses value) quicker than the long-dated option. In addition you hope that your purchased long-dated option covers you against adverse movements on the short position in the short-dated options. "
Indeed, VIX futures do behave like options. Unlike "regular" index futures, VIX futures are non-linear in the index. That means that besides delta VIX futures also have gamma and theta. The last one is the most obvious, and is indeed observed in the marketplace. As one can see, most of the price decay occurs closer to expiration. The applet below demonstrates VIX daily decay as a function of different parameters.
If you do not see the applet above you may need to download shockwave player from Adobe (same company that makes Flash player, and Pdf reader)
Surlytrader writes "Consider this the cost of holding the long position over time. This is important because we can think about VIX futures trades much like we think about calendar spreads in the options world. In a calendar spread you buy a longer dated option and sell a short dated option. You hope that the short-dated option decays (loses value) quicker than the long-dated option. In addition you hope that your purchased long-dated option covers you against adverse movements on the short position in the short-dated options. "
Indeed, VIX futures do behave like options. Unlike "regular" index futures, VIX futures are non-linear in the index. That means that besides delta VIX futures also have gamma and theta. The last one is the most obvious, and is indeed observed in the marketplace. As one can see, most of the price decay occurs closer to expiration. The applet below demonstrates VIX daily decay as a function of different parameters.
If you do not see the applet above you may need to download shockwave player from Adobe (same company that makes Flash player, and Pdf reader)
VSTOXX Market-Maker Interview
Understanding VIX Futures Movement, Part 2
Part 1 here, part 3 here. Everyone knows that VIX futures (and ETFs) do not move one to one with the index. Given the complicated dynamics of the index - jumps, multiple regimes, mean-reversion - it is actually not surprising that replicating the index in a tradable instrument is not trivial. However there's very little info about quantifying the relationship.
In this excellent article surlytrader talks about imperfect correlation between VIX futures and the index, writing "... VIX futures become less correlated to the spot VIX index as you move further out in expirations. ... By investing further out on the curve, we do not capture as much of the movements of the VIX spot index. On the flip side, by investing further out on the curve, we lose less as the futures contract ages." Surlytrader also provides a plot with schematic depiction of correlation declining with time to maturity. In the plot he calls it VIX Beta, but I thought that VIX Delta would be more in line with the convention.
To explain the relationship I created an applet that quantifies and illustrates this dynamic relationship between futures prices, tenor, and correlation to the index. One of the most intuitive features is the effect of mean-reversion parameter on the price and delta. When mean reversion is large VIX futures converge quickly to their long-term level, and delta quickly decays toward 0. When mean-reversion is small (e.g. like it is in the stock market) then more familiar dynamics emerge - futures are "connected" to the index level, and correlation is high.
If you do not see the applet above you may need to download shockwave player from Adobe (same company that makes Flash player, and Pdf reader)
One of the practical applications of VIX futures delta is trading calendar spreads on VIX futures /options / ETFs, and measuring position risk.
In this excellent article surlytrader talks about imperfect correlation between VIX futures and the index, writing "... VIX futures become less correlated to the spot VIX index as you move further out in expirations. ... By investing further out on the curve, we do not capture as much of the movements of the VIX spot index. On the flip side, by investing further out on the curve, we lose less as the futures contract ages." Surlytrader also provides a plot with schematic depiction of correlation declining with time to maturity. In the plot he calls it VIX Beta, but I thought that VIX Delta would be more in line with the convention.
To explain the relationship I created an applet that quantifies and illustrates this dynamic relationship between futures prices, tenor, and correlation to the index. One of the most intuitive features is the effect of mean-reversion parameter on the price and delta. When mean reversion is large VIX futures converge quickly to their long-term level, and delta quickly decays toward 0. When mean-reversion is small (e.g. like it is in the stock market) then more familiar dynamics emerge - futures are "connected" to the index level, and correlation is high.
If you do not see the applet above you may need to download shockwave player from Adobe (same company that makes Flash player, and Pdf reader)
One of the practical applications of VIX futures delta is trading calendar spreads on VIX futures /options / ETFs, and measuring position risk.
Week in Volatility
S&P and STOXX were up this week 1.8% and and 1.3% - pretty much non-event except for the roller-coaster on Friday. VIX and VSTOXX futures moved lower by about 0.75 points. Meanwhile I came across this article indicating that prices for long-term vol derivatives are historically very high. If anyone knows where I can get more data on this, please email me.
Like I wrote earlier the term-structure of VSTOXX futures is much flatter than VIX, and I believe it provides an excellent opportunity for relative trade.
Like I wrote earlier the term-structure of VSTOXX futures is much flatter than VIX, and I believe it provides an excellent opportunity for relative trade.
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