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Over the past week VIX August futures were almost unchanged while the rest of the curve experienced a small downward shift. The S&P 500 gained 0.4% in this period (Figure 19). The realized volatility of VIX futures and VXX continued to be high last week (Figures 13, 30). VIX August implied volatility increased last week while the longer maturity implied volatilities remained at the same levels (Figure 27). VIX 1M skew steepened last week and is now close to its last one-year high (Figure 25).
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CONTENTS
VOLATILITY LIQUIDITY LANDSCAPE VIX ETNS-1 VIX ETNS-2 VSTOXX ETNS VIX FUTURES VIX OPTIONS-1 VIX OPTIONS-2 HEDGING STRATEGIES VIX ETNS & VIX OPTIONS HEDGING STRATEGIES - COMPARISON ALPHA STRATEGIES ALPHA STRATEGIES COMPARISON MARKET INTELLIGENCE HEDGING STRATEGIES: METHODOLOGY ALPHA STRATEGIES: METHODOLOGY SELECTED VIX-RELATED PUBLICATIONS
3 4 5 6 7 8 9 10 11 12 13 14 18 22 26
Total Vega Outstanding is the weekly moving average of the daily vega outstanding.
Total Vega Volume is the weekly moving average of the daily vega volumes traded.
For more information on the charts please click the figure title
VIX ETNS-1
Figure 3: Price Performance of VXX & VXZ
120 100 80 60 40 20 0 Jul-10 Nov-10 VXX Mar-11 VXZ
Prices are normalized to 100 at the starting date to compare the performance.
Roll cost is estimated using the term structure premium in VIX futures.
Jul-10
Apr-11
Vega per share on day t is calculated as the ratio of the VIX ETN and the relevant constant maturity VIX future on day (t-1).
VIX ETNS-2
Figure 9: VXX & VXZ Vega/Share
4.0 3.5
Contracts('000)
3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jul-10 Nov-10 VXX Mar-11 VXZ
Open Interest(RHS)
1M IV
1M IV
Skew = (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)
Contracts('000)
VSTOXX ETNS
Figure 15: Price Performance of VSXX (in )
35 30 25 20
60
Jul-10
VSXX Price ()
AUM (MM )
Volume(MM ) (RHS)
VIX FUTURES
Figure 17: VIX 1M & 4M Constant Maturity
35 33 31 29 27 25 23 21 19 17 15 Jul-10 Nov-10 VIX Future 1M Mar-11 VIX Future 4M
Future Today
Hedge Ratios are calculated using past 2 year overlapping weekly returns.
Volume(LHS)
Open Interest(RHS)
VIX OPTIONS-1
Figure 23: VIX 1M and 2M ATM Volatility
120% 110% 100% 90% 80% 70% 60% Jul-10 Nov-10 ATM 1M IV Mar-11 ATM 2M IV
1M IV
Skew= (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)
Figure 27: VIX ATM Volatility and Open Interest Term Structure Snapshot
110% 100% 90% 1500 80% 1000 70% 60% 50% Aug-11 Sep-11 Oct-11 VIX ATM IV Today Nov-11 Dec-11 Expiry 500 0 2500 2000 Contracts('000)
VIX OPTIONS-2
Figure 28: VIX Option Call and Put Open Interest
7,000 6,000 Contracts('000) 5,000 4,000 3,000 2,000 1,000 0 Jul-10 Dec-10 Apr-11 Call Open Interest Put Open Interest
Figure 30: VIX Vol versus SPX Skew and VIX Fut. Realized Vol
100% 90% 80% 70% 60% 50% 40% 30% 20% Jul-10 VIX 2M IV Nov-10 Mar-11 VIX Future 1M RV 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%
Skew = (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)
S&P 500
SPX + SPVXSTR
S&P 500 portfolio is hedged with 40% dollar notional VIX 3M 20% OTM calls.
VIX 1M 80%- 120% risk reversal of 30% dollar notional is used for hedging.
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Strategies
Average Return
Standard Deviation
Sharpe Ratio
Sortino Ratio
Drawdown
1 Week Return
3 Month Return
S&P 500 SPX Hedged with long 3M 120% VIX CallOption SPX Hedged with short 1M 80%-120% VIX Risk Reversal SPX Hedged with short 3M 120% 150% 1x2 VIX Call Spread SPX Hedged with long SPVXSTR SPX Hedged with long SPVXMTR SPX Hedged with long SPVXMTR & short SPVXSTR SPX Hedged with 12M Zero Cost 80% 95% SPX Put Spread Collar
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ALPHA STRATEGIES
250
250
200
200
150
150 100 50
Nov-07 Aug-08 Jun-09 Apr-10 Jan-11
100
50 Jan-07
Jan-07
Nov-07 Aug-08
Jun-09
Apr-10
Jan-11
Figure 42: Long 1M ATM VIX Put & Short 2M Same Strike Put
230 210 190 170 150 130 110 90 70 50 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11
Dollar notional for both long and short puts is 100% of the portfolio equity.
Weights for different strategies are calculated using past 3M realized volatility over overlapping weekly returns.
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Strategies
Average Return
Standard Deviation
Sharpe Ratio
Sortino Ratio
Drawdown
1 Week Return
3 Month Return
S&P 500 SPVXSTR versus SPVXMTR Delta Hedged 1M ATM VIX Straddle VIX 1M 80%-100% 1x2 Put Spread VIX Long 1M ATM Put and Short 2M Same Strike Put Long VST1MT Short SVPXSTR Equal Volatility Combined Strategy
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VIX ETNs-1
Figure 3: Price Performance of VXX and VXZ: Price performance of VXX and VXZ is plotted for a trailing one-year period. Prices are normalized to 100 at the start date to directly compare the performance of the two ETNs. Figure 4: Estimated VXX and VXZ Monthly Roll Cost: We estimate the roll cost of the VXX and VXZ using the term structure of constant maturity VIX futures. Assuming that the volatility surface remains constant, roll cost of VXX can be estimated as 0.5*(VIX 2M future VIX)/(VIX 1M future). Applying the same assumptions, VXZ roll cost is estimated as 0.5*(VIX 6M future VIX 4M future)/(VIX 5M future). Constant maturity VIX futures are calculated here by linearly interpolating VIX futures for the given constant maturities. Figure 5: VXX and VXZ Vega Outstanding: Vega outstanding of the VIX ETNs is calculated as the open interest of the ETNs times their respective vega per share. Time series of vega per share for VXX and VXZ is shown in Figure 9: VXX & VXZ Vega/Share. Figure 6: VXX and VXZ Vega Volume: Similar to the calculations of vega outstanding of the VIX ETNs, vega volume is simply vega per share times the trading volume of each ETN. The figure shows weekly moving average of the daily vega volume of the ETNs.
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Figure 7: VXX Short Interest and XXV Vega Outstanding: To get an idea of the amount of VXX being shorted, we show VXX short interest vega and XXV outstanding vega in the figure. We calculated the short interest vega of VXX as the vega per share times short interest of VXX. The figure shows two data points for each month as short interest is published only twice a month. Figure 8: Notional of VIX ETN to hedge $100 of SPX: Simple linear regression is used to calculate the hedge ratio of SPX with respect to the ETNs (VXX and VXZ). We use overlapping weekly returns over the trailing six months for the regression.
VIX ETNs-2
Figure 9: VXX and VXZ Vega/Share: The vega/share on day t of VIX ETNs (VXX and VXZ) is the ratio of the close price of the VIX ETN and the corresponding constant maturity VIX future on day t-1. The vega/share reflects the change in the price of VIX ETNs corresponding to 1 point parallel shift in VIX futures across the term structure. Figure 10: VXX Option Open Interest and Volume: To monitor the liquidity of VXX options, open interest and volume of VXX options are shown in the figure. The graph has data from May 2010, which was when VXX options listed. Figure 11: VXX Vol Term Structure and Open Interest: We plot at-the-money (50 Delta) implied volatility of VXX for listed maturities to get the snapshot of VXX volatility term structure. Also shown is the open interest in various listed options contracts on VXX for the same expirations. 50 Delta implied volatility is calculated by taking the average of 50 Delta Call and Put implied volatilities. Figure 12: VXX Skew Snapshot: VIX futures are inversely correlated to SPX and hence VXX, which is a portfolio of long 1M and 2M VIX futures, and is also inversely correlated to SPX. This inverse correlation is reflected in the opposite skew of VXX (OTM calls having a higher implied volatility than OTM puts) with respect to SPX. The figure shows the snapshot of VXX 1M and 2M implied volatility across standardized put deltas. Figure 13: VXX 1M and 2M Implied Volatility Time Series: Time series of at-the-money (ATM) (50 Delta) implied volatility of VXX for standardized maturities 1M and 2M are shown since May 2010, which was when VXX options listed. Figure 14: VXX Skew Time Series: The figure plots the times series of the 1M and 2M VXX skew since May 2010. Skew here is defined as (25D Put Vol)/(50D Put Vol) - (25D Call Vol)/(50D Call Vol).
VSTOXX ETNs
Figure 15: Price Performance of VSXX (in ): ETNs linked to VSTOXX futures started to trade in September 2010 on several European exchanges (Frankfurt, both Euro and GBP denominated listings on London). This figure plots VSXX price performance using closing prices from the Frankfurt exchange, which has the highest liquidity. Figure 16: Total VSXX Volume and Shares Outstanding (in ): Total daily volume and shares outstanding are calculated by summing across all exchanges, converted into euros. Weekly moving average of this daily volume (calculated above) is plotted in this figure.
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VIX Futures
Figure 17: VIX 1M and 4M Constant Maturity: The constant maturity futures are calculated by interpolating the VIX futures term structure using an exponential fit. Constant maturity VIX futures help identify the pure price performance of VIX futures, without taking into account the roll cost. Figure 18: Performance of VIX Futures Rolled at Expiry: In contrast to VIX ETNs, which are rolled daily, we have also plotted the performance of strategies where VIX futures are only rolled each month at the VIX futures expiration date. In Figure 18: Performance of VIX Futures Rolled at Expiry, we show the performance of 1M VIX future held until it expires and of 4M VIX future held for one month until VIX futures expiration date (it is now a 3M VIX future), at which point it is rolled to the next 4M future. As we can see, rolling daily improves performance relative to monthly rolling. Figure 19: VIX Futures Term and Open Interest Snapshot: This figure plots the current VIX futures term structure and the term structure from one week back. The figure gives an idea of the movement in the term structure over the past week. Figure 20: Hedge Ratio of VIX Futures versus SPX: Shorter-dated VIX futures are more sensitive to movements in SPX relative to longer-dated futures. This is reflected in the higher hedge ratio of SPX relative to longer-dated VIX futures, or in other words more longer-dated VIX futures are required to hedge a given SPX position in comparison to shorter-dated futures. Hedge ratio is calculated using simple linear regression of SPX versus VIX futures overlapping weekly returns over the last two years. Figure 21: VIX Futures Slope: The slope of the VIX term structure is usually steep in the short end and flattens toward longer-dated futures. The ratio of the 1M/2M VIX futures gives an indication of the steepness of the nearer end of the curve while the ratio of 4M/3M VIX futures measures the steepness in the longer-dated part of the curve. Figure 22: Aggregate VIX Futures Volume and Open Interest: The curve here shows VIX future volume and open interest across all the maturities for the last 1 year. Volume is the weekly moving average of the daily volumes.
VIX Options 1
Figure 23: VIX 1M and 2M ATM Volatility: To calculate the VIX volatility surface, we first note that the underlying for each VIX option with different maturity is a different VIX future. We calculate the implied volatility for each option contract with the underlying VIX future having the same maturity as the expiry of the option contract. We only keep options with absolute delta between 5 and 75 to remove points where implied volatility calculation is very sensitive to bid ask spreads. We then use a simple quadratic regression for each option expiry to identify and correct other outliers. A localized kernel regression method is employed over the corrected data to parameterize the implied volatility for given standard deltas and expiries. Localized kernel regression method helps us preserve the shape of the implied volatility surface without placing simplified constraints about the shape of the surface. VIX ATM volatility is defined as the implied volatility of 50 delta option. Figure 24: VIX 1M and 2M Skew Snapshot: Negative correlation between VIX futures and SPX returns implies that the sign of VIX skew is flipped with respect to SPX skew. In the figure we plot implied volatility of standardized VIX options using the volatility surface to show the skew of 1M and 2M VIX options.
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Figure 25: VIX 1M and 2M Skew: We calculate VIX skew as: (25D Call Vol)/(50D Call Vol) (25D Put Vol)/(50D Put Vol). The formula used to calculate the skew of VIX is opposite in sign to the formula used for calculating SPX skew in Figure 30. Figure 26: VIX 2M/1M ATM Volatility Ratio: Longer-dated VIX futures are less volatile than shorter-dated futures. As the VIX futures approach expiry, their volatility increases leading to a downward sloping term structure of VIX volatility. The figure shows the ratio of 2M ATM VIX Volatility and 1M ATM VIX Volatility. Figure 27: VIX ATM Volatility and Open Interest Term Structure Snapshot: VIX ATM volatility is the implied volatility of 50 delta option for the listed expiries. The figure compares the latest term structure of volatility of VIX with the term structure one week back.
VIX Options 2
Figure 28: VIX Option Call and Put Open Interest: Open interest in the figure is the aggregate open interest across all the maturities. Historically, call option open interest has been significantly higher due to higher demand for out-of-the-money VIX call options, used for hedging equity portfolios. Figure 29: VIX Option Call and Put Volume: Similar to the open interest shown in Figure 28, the volume shown is the weekly moving average of the aggregate volume of VIX options across all maturities. Figure 30: VIX Vol versus SPX Skew and VIX Fut. Realized Vol: As discussed previously in Index Volatility Weekly Valuing Vol of Vol September 28, 2009, VIX ATM volatility very closely tracks SPX skew. An intuitive explanation for this effect comes from using a simple sticky strike model. We can provide (slightly) more rigour by using an explicit stochastic volatility model. Perhaps the simplest stochastic volatility model is the SABR model where we can write:
imp ( K ) = o log
K So
Thus the skew (defined as the coefficient of the log strike) is directly proportional to the volatility of instantaneous volatility. In this simple model VIX volatility will also be proportional to and is thus proportional to the SPX skew. As an aside, note that, if the correlation is -1, then we immediately see that this is equivalent to a sticky strike model. The above model is too simplistic in that it ignores the mean reversion of volatility which leads to a declining term structure of VIX volatility. Figure 31: 2M ATM SPX Volatility versus 2M VIX Skew: VIX skew has strong correlation with SPX ATM volatility.
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according to the gain or loss from the option position and the interest incurred on the borrowing. While VIX call options lose money in most months, they work well in instances where equity markets experience large negative returns. In that respect they are much more of a tail hedge, which is why we prefer 20% OTM call options in comparison to ATM call options. It is also cheaper to carry longer-dated option since the implied volatility of VIX options has usually been the richest in the shorter end. In terms of performance they outperform long equity but underperform some other VIX option hedges that try to reduce the cost of the hedge by selling some other option in addition to the long call leg.
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and keeping the options to expiration. While this hedge outperforms a stand-alone long equity position, it underperforms most of the VIX ETNs and VIX options-based hedges.
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volatility points. Assuming our rule of a maximum 25% draw-down, this would translate into a vega of ~0.15 per $100 of equity. As we have shown before, front month VIX options have historically been the most expensive, which makes them good candidates for selling delta hedged straddles. Each month we sell 0.15 Vega of ATM straddles for $100 of equity. The straddle is delta hedged on daily basis. The money received from selling the straddles is deposited at the Fed funds rate. The cash level is adjusted at the expiry for the gain or loss from selling the straddles and delta hedging them. It is interesting to note that the realized volatility of VIX options remains in a narrower band of its average implied volatility relative to SPX, where the divergence can be much greater. This makes selling VIX straddles attractive relative to a similar trade in SPX which also has a lower Sharpe ratio during the same period.
calendar trade is for the term structure to invert with the longer-dated put being in the money while the shorter-dated put expires out of the money. However, the inversion of the term structure is usually associated with an increase in the levels of volatilities, which should result in even the second month options being out of the money. While it is difficult to estimate the possible losses in the trade, in many ways it is a less risky trade than the 1x2 put spread or the VXX vs. VXZ trade since an inversion of the surface is likely to be associated with a leg up for volatilities, which should keep the draw-down low. We size the trade similar to the 1x2 put spread with the notional of both front month and second month options equaling the cash held.
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Historically, the combined strategy has achieved higher risk-adjusted returns and lower draw-downs compared to the other VIX strategies considered.
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premium. We show how trading VIX futures through VXX and VXZ to monetize term structure premium is similar to monetizing this premium through variance swaps. Index Volatility Weekly - VIX Options Trading Strategies: A Deep Dive April 19, 2010 We present an extensive analysis of VIX option strategies for expressing views on volatility and hedging equity portfolios. We evaluate these strategies to analogous trades using SPX options. Hedging Credit Portfolios with VIX ETNs April 06, 2010 We analyze the performance of VIX ETNs (VXX and VXZ) along with SPX as hedges for investment grade (IG) and high yield (HY) credit portfolios. Understanding VIX ETNs Conference Call March 08, 2010 Through this conference call presentation, we address several important facets of VIX ETNs to facilitate better understanding of the VIX ETNs. VIX ETNS: A User's Manual February 24, 2010 - In this report we collect the numerous queries we have fielded from investors around VIX futures ETNs (the VXX and VXZ). It is organized in the form of Frequently Asked Questions which should make it more convenient as a reference manual for investors. Volatility of Volatility Risk Premium February 16, 2010 Performance of systematically trading the premium between implied and subsequent realized volatility in options on VIX futures is analyzed. We compare the performance of selling VIX options relative to selling SPX options and quantify the effect of bid-offer spreads in VIX options on the performance of the strategy.
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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass Analyst Certifications We, Maneesh S. Deshpande and Rohit Bhatia, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Important Disclosures The analysts responsible for preparing this report have received compensation based upon various factors including the Firm's total revenues, a portion of which is generated by investment banking activities. For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 1-212-526-1072. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. Risk Disclosure(s): Options are not suitable for all investors. Please note that the trade ideas within this report do not necessarily relate to, and may directly conflict with, the fundamental ratings applied to Barclays Capital Equity Research. The risks of options trading should be weighed against the potential rewards. Risks Call or put purchasing: The risk of purchasing a call/put is that investors will lose the entire premium paid. Uncovered call writing: The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received. Uncovered put writing: The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received. Call or put vertical spread purchasing (same expiration month for both options): The basic risk of effecting a long spread transaction is limited to the premium paid when the position is established. Call or put vertical spread writing/writing calls or puts (usually referred to as uncovered writing, combinations or straddles (same expiration month for both options): The basic risk of effecting a short spread transaction is limited to the difference between the strike prices less the amount received in premiums. Call or put calendar spread purchasing (different expiration months & short must expire prior to the long): The basic risk of effecting a long calendar spread transaction is limited to the premium paid when the position is established. Because of the importance of tax considerations to many options transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated options transactions. Supporting documents that form the basis of our recommendations are available on request. The Options Clearing Corporation's publication, "Characteristics and Risks of Standardized Options", is available at http://www.theocc.com/publications/risks/riskchap1.jsp Barclays Capital offices involved in the production of Equity Research: London Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Capital Japan Limited (BCJL, Tokyo) So Paulo Banco Barclays S.A. (BBSA, So Paulo) Hong Kong Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong) Toronto Barclays Capital Canada Inc. (BCC, Toronto) Johannesburg Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg) Mexico City Barclays Bank Mexico, S.A. (BBMX, Mexico City)
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