Short Volatility Trading with Volatility Derivatives

Russell Rhoads, CFA

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Options 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.

Disclosure

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Cboe Volatility Index Primer VIX FuturesVIX Options Summary / Contact

Short Volatility Trading

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The Cboe Volatility Index® or the VIX® Index is a consistent 30 day measure of implied volatility as indicated by S&P 500® Index option prices The VIX Methodology is considered the industry standard for a consistent measure of implied volatility Historically the VIX Index has displayed an inverse relationship with the S&P 500 which resulted in it being referred to as “the fear index”

Cboe Volatility Index

5Data Sources: Cboe Global Markets and Bloomberg

Cboe Volatility Index

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VIX vs. S&P 500 Daily 2017

S&P 500

VIX

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VIX vs. SPX January 2018

Data Sources: Cboe Global Markets and Bloomberg

Cboe Volatility Index

S&P 500

VIX

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VIX vs. SPX 2018 January and February 2018

Data Sources: Cboe Global Markets and Bloomberg

Cboe Volatility Index

S&P 500

VIX

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Contract Specifications The value of a VIX futures contracts is $1000 times the quoted valueMinimum ticks are 0.05 ($50) for single contract trades and 0.01 ($10) for calendar spreadsThere are both standard and weekly contracts available for trading – currently the majority of volume is concentrated in the standard expirationsTrading is available almost 24 / 5 with small breaks after the end of regular US trading hours Expirations typically occur on Wednesdays and the futures are AM settled

VIX Futures

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Pricing Unlike 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 at times VIX futures will be priced at a discount The pricing relationship is often referred to as being in contango or backwardation

VIX Futures

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Contango / Backwardation

VIX Futures

VIX Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Month 7 Month 8 Month 9

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Backwardation – Impact of Brexit Referendum

Data Source: Cboe Global Markets

VIX Futures

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VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17

Friday 6:30 AM Chicago

Thursday US Closing

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Standard Futures Daily Pricing

Data Source: www.Cboe.com

VIX Futures

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9/16 10/7 10/28 11/18 12/10

Dec 2015 VIX Future

Spot VIX

Dec Front Month

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Trading Example –August 14, 2014

VIX @ 12.42Sell 1 August VIX @ 12.95

August 19, 2014VIX @ 12.21

Buy 1 August VIX @ 12.20

Profit = 0.75

Trades into Expiration

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Trading Example –August 14, 2014

VIX @ 12.42Sell 1 August VIX @ 12.95

Buy 1 September VIX @ 13.90

August 19, 2014Buy 1 August VIX @ 12.20 (+0.75)

Sell 1 September VIX @ 13.50 (-0.40)

Profit = +0.35

Trades into Expiration

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Trading Example –January 10, 2018

VIX @ 9.82Sell 1 January VIX @ 10.55

January 16, 2018VIX @ 11.66

Buy 1 January VIX @ 11.75

Loss = -1.20

Trades into Expiration

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Trading Example –January 10, 2018

VIX @ 9.82Sell 1 January VIX @ 10.55

Buy 1 February VIX @ 11.55

January 16, 2018VIX @ 11.66

Buy 1 January VIX @ 11.75Sell 1 February VIX @ 12.10

Loss = -0.65

Trades into Expiration

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VIX Index options are cash settled contracts that share an expiration date with a VIX FutureTraders are better served using VIX Futures as the best underlying pricing vehicle for valuing VIX Options This means that VIX Option positions are best priced off futures but settle in the spot index The multiplier for VIX Options is $100 and trading is available during both European and US market hours

VIX Options

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Friday August 12, 2016 – VIX at 11.50 / Sep VIX Futures at 15.00

VIX Options

Call Bid Call Ask Strike Put Bid Put Ask4.80 5.10 10 0.00 0.053.90 4.10 11 0.00 0.053.10 3.30 12 0.15 0.202.40 2.55 13 0.45 0.551.90 2.05 14 1.00 1.051.55 1.65 15 1.60 1.701.35 1.45 16 2.35 2.451.10 1.25 17 3.10 3.30

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VIX at 11.50 / September VIX at 15.00

Believe VIX Will Remain LowConsidering Buying a VIX Put

VIX Options

Put Strike Ask Price Break Even P/L VIX @ 11.5012 0.20 11.80 0.3013 0.55 12.45 0.9514 1.05 12.95 1.4515 1.70 13.30 1.8016 2.45 13.55 2.0517 3.30 13.70 2.20

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Buy 1 VIX Sep 14 Put at 1.05

VIX Options

-2.00

-1.00

0.00

1.00

2.00

3.00

4.00

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VIX @11.50

VXU6 @15.00

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Bear Call Spread #1

March 23, 2016VIX @ 14.75

May VIX @ 19.05

Sell 1 May VIX 25 Call at 1.25Buy 1 VIX May 28 Call at 0.85

Net Credit = 0.40

VIX Options

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Bear Call Spread #1

VIX Options

-3.00

-2.00

-1.00

0.00

1.00

2.00

16 19 22 25 28

VIX @14.75

VXK6 @19.05

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Bear Call Spread #2

March 23, 2016VIX @ 14.75

May VIX @ 19.05

Sell 1 May VIX 22 Call at 1.70Buy 1 VIX May 30 Call at 0.70

Net Credit = 1.00

VIX Options

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Bear Call Spread #2

VIX Options

-9.00

-6.00

-3.00

0.00

3.00

6.00

14 16 18 20 22 24 26 28 30 32

VIX @14.75

VXK6 @19.05

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Both VIX futures and options offer opportunities to short market volatility Recent market action reminds us to have risk controls in place when taking a short volatility position

Short Volatility Trading

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Linkswww.Cboe.com/vixwww.cfe.Cboe.com

www.Cboe.com/blogs

Contact InformationRussell Rhoads, CFArhoads@Cboe.com

Twitter - @RussellRhoads

Useful Links / Contact Information