Imagine having a tool that enabled you to capture profits regardless of market direction. I am not talking about esoteric option positions that require a rocket scientist to design and implement.
This is a single future that is easy to trade and will allow you to profit from changes in market volatility and not direction. This tool is the VIX futures, traded on the Chicago Future's Exchange (CFE) a division of the CBOE.
These futures follow the VIX Index and are a pure play on implied volatility regardless of stock prices or directional movement. Let's say you know a market-rocking event is occurring or you expect one soon. This event could be geo-political, economics on the world stage, or simply surprising domestic financial news. However, it remains unknown what way the market will react to the event or information.
As you know, the market often reacts in a non-intuitive manner to events or information. It can go up on seemingly bad news, and down on good news. One would go long VIX futures to capture profits based on the volatility itself without regard to knowing the directional move triggered by such an event.
One would short the VIX futures if decreasing volatility is expected with the same old same old repeating itself. There are also options available on the VIX futures. The calls are perfect tools to sell if you believe that things will stay the same within the time frame of the option.
What is the VIX Index?
Simply stated, the Volatility or VIX Index measures the markets expectation of 30 day volatility as shown by near-term S&P 500 options. It was first introduced in 1993 and is based on a paper written by Duke University Professor Robert Whaley.
In 2004 VIX futures were introduced and options began trading in 2006. Today, many market analysts and traders consider the VIX to be the premier gauge of market sentiment and volatility. Regarding VIX futures, they trade in a size of 1000 times the VIX on the contract months up to six near-term serial months and 5 months on the February quarterly cycle.
Each tick is $10.00, they trade between 8:30a.m. and 3:15p.m. Central Standard Time and are available on the CBOE direct platform. There is much more outside the scope of this article to learn about the VIX and its structure. The CBOE has top notch information on its site, should you desire to learn more about the VIX itself and the VIX futures/options.
Why Today?
Now that I have provided a very brief synopsis on the VIX and VIX futures, why am I bringing this up today? Yesterday, the VIX fell to its lowest level since July 2007 at 15.82. It has fallen by more than 50% since its March high of 35.60. I believe this is due to the rally in stocks and the Fed stepping in to help the faltering economy.
Volatility is generally greater when stocks fall, with all other things being equal. July VIX futures are telling a different tale. They seem to be reflecting a belief that Volatility will increase this summer.
In fact, just yesterday the VIX rose 3.3% after hitting the low. There is great underlying risk inherent in the market; I believe that we will see bigger swings and more volatility in the rest of 2008.
Dave Goodboy is Vice President of Marketing for a New York City based multi-strategy fund.
