Options  |  AUG 2004

The New Volatility Futures by Larry McMillan

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).

by Larry McMillan