As the November 8 date for the U.S. Presidential election approaches, I have heard quite a bit of interest from investors in the use of SPX and VIX options and VIX futures with various expirations over the next six weeks. Added expiration dates provide investors with the opportunity to implement more targeted buying, selling, hedging and spreading strategies.
As shown in the two tables below, a September 28 CBOE Circular, and on cboe.com, by the end of next week there will be SPXW option expirations on Nov. 2, 4, 7, and 9, and there are (or will be) expirations for both VIX futures and options on Nov. 2, 9, and 16.
SKEW CHART AND SPX EXPIRATIONS
The Livevol Pro skew chart below shows the estimated implied volatilities for S&P 500 options at various strike prices and many expirations mid-day on September 30. Note that, for example, the estimated implied volatility for the 1730 SPXW puts expiring on Nov. 11 is 29.35.
FEATURES OF THE NEW SPX MONDAY-EXPIRING WEEKLYS OPTIONS
Trading Hours — Extended and Regular Trading Hours currently in place for the existing SPX/SPXW options are being followed.
Ticker Symbol — SPX Monday-expiring Weeklys series are available for trading under option symbol SPXW.
Expiration and Final Trading Day
• SPX Monday-expiring Weeklys options are PM-settled.
• The expiration date (usually a Monday) will be identified explicitly in the expiration date of the product. If the Monday of the week in which the options expire coincides with an Exchange holiday, the expiration date will be on the next business day (usually a Tuesday). The expiration date for each option is also the last trading day for that option.
• SPX Monday-expiring Weeklys may expire on any Monday of the month, other than a Monday that coincides with an End-of-Month (“EOM”) expiration date.
• Expiring SPX Monday-expiring Weeklys options will cease trading at 3:00 p.m. Central time on their last trading day. All non-expiring SPX Monday-expiring Weeklys options will continue to trade until 3:15 p.m. Central time.
• SPX Monday-expiring Weeklys option series will not be included in the strip of option series that will be used to calculate the CBOE Volatility Index (“VIX Index”) spot value or the exercise or final settlement value of VIX Index options and futures.
The microsite for SPX Weeklys options is at www.cboe.com/SPXW.
Andy Nybo from Tabb Group delivered a presentation and then headed a panel discussion on The Evolution of Options and Futures Strategies on the Buyside Trading Desk at CBOE’s RMC Conference Wednesday. The panelists that followed Nybo’s presentation were:
- Jared Dubin, Head of Systematic Strategy Research, LMR Partners
- John Fennell, Executive Vice President, Financial Risk Management, The Options Clearing Corporation
- Patrick A. Luongo, head of AES Options Sales, Credit Suisse
- Alex Orus, Founder and Partner, Principalium Capital AG
The presentation portion of the session discussed trends in the markets focusing on three areas. First, it was noted that global regulatory pressure to reduce systemic risk is moving demand to exchange traded products. For instance, an aggressive trading strategy may be forced to use listed markets as brokers restrain credit. Second, listed broad based equity index derivatives are becoming a bigger part of investment strategies. With the expansion of investment mandates has resulted in a wider use of index derivatives and increased volatility will reinforce any demand for risk management activities. A final point that was made noted that market participants are drawn to markets that have efficient liquidity when entering or exiting positions, especially at times when volatility surges.
This presentation also took advantage of CBOE’s dive into live polling at RMC. The first question gauged the interest of attendees with respect to access to VIX Futures during non-US trading hours.
The audience was probably skewed, but 87% of respondents found it desirable for traders to have access to VIX futures during the extended hours session.
The second question was about SPX and VIX option trading during non-US hours.
The response to this second question was very similar to the first with 85% of responses in the Moderate or Very category. Part of me wondered if both of these surveys would have seen more responses on the “Very” category if we had asked the questions just after the market reaction to Brexit this past Summer.
Three presenters worked together on a presentation that asks the question, Can We Improve Trading Using Correlation Information? Kokou Agbo-Blou from Societe Generale, Neale Jackson of 36 South Capital Advisors, and Trung-Tu Nguyen of Capital Fund Management all divided duties to answer this question.
Each speaker took on various parts of the presentation relating to their individual expertise. The presentation discussed the difference between long-term correlations and short-term correlations. This theme was ever present over the three days of RMC, but discussed more often as current market dislocations.
With respect to dealing with highly correlated assets, it was suggested that traders look at four different asset classes for diversification purposes. These classes are long stock index futures, short equity variance swaps, short volatility index futures, and buying credit default swaps. For each class US and EU versions of returns were used and compared.
There was an analogy drawn to show a Nash Equilibrium proving necessity for a convex response. This was possibly the most entertaining demonstration and definitely the first time I’ve seen a duel with (fake) pistols play out at an investment conference. The point being made was hedging is not a linear decision and approaching a long volatility strategy in a portfolio can result in a dynamic correlation gap if managed improperly. If you are up against a good shooter in a duel you are probably going to take large steps so you are a smaller target. If you are up against a terrible shot, maybe you take shorter steps. Either way, the length of your pace is determined by you assessment of your opponent.
Finally, a table was shown noting the time periods for SPX volatility to move from a peak to a trough. We are all aware of how quickly VIX dropped back in the August / September period last year. However, the typical cycles have run in the 30 to 50-day range since 2005 (for context the peak to trough last year was only 6 days). Since this anomaly from last year, the cycles have run 51, 28, and 30 days – resuming was we had experienced in the past.
Christopher Cole who is a Managing Partner at Artemis Capital Management kicked off the final day of the 5th Annual European of CBOE’s Risk Management Conference. He gave his view of the current market environment while also framing the discussion around a paper he authored, Volatility and the Allegory of the Prisoner’s Dilemma. A PDF of that paper may be found here – Cole Volatility paper
I was fortunate enough to see Chris speak on this paper in the past. Although he presented this topic to a similar audience, he had several different points to make and included several entertaining analogies over the course of his talk. He invoked broad images, spanning the character from the movie Ant Man to referring to the equity market having Jekyll and Hyde periods with respect to volatility.
A point I found particularly interesting was the impact that the equity market feels from corporate buybacks. He called what is going on in the US a leveraged buyout of the S&P 500. He mentions that never in history have we had a market have a bull run on falling volume, but that is exactly what is currently going on. The reason stock trading volumes are declining is because there are fewer shares available to trade. His feeling is this trend will eventually end badly for the US equity market.
He mentioned that the equity markets go through Dr. Jekyll and Mr. Hyde phases. Mr. Hyde, the calm persona, occurs when companies are allowed to buy back shares. In periods where companies are prohibited from buying back shares, such as leading up to an earnings announcement, the market tends to be more volatile, hence the reference to Dr. Jekyll.
As a final note, Chris commissioned a video, “Volatility at World’s End” which is a visual look at SPX volatility from 1991 through 2011. It is an entertaining reminder of what the markets went through about 8 years ago. That may be viewed at the following link – https://youtu.be/xlKWdd_DhW0
For the final presentation of the second day at CBOE RMC Europe, Abhinandan Deb from Bank of America Merrill Lynch and Michael Stephens from Pioneer Investment Management split duties to discuss Global Volatility Trading Opportunities with a Focus on Europe.
Their talk spent some time discussing the fallout from Brexit and potential market fragmentation risk along with geopolitical and central bank risk. They also discussed the impact of structural investor flows and strategies to gain alpha and manage risks.
It was noted that the global equity markets do not appear to be discounting much risk to performance. Stated more plainly, volatility does not explain the real risk of managing assets. Central banks appear to be focusing more on the markets than the actual economic outlook. The result is whenever there is a tantrum in the equity markets the result is a central bank response that calms the markets. The risk is when central banks run out of ammo or market participants begin to lose confidence in central banker’s ability to effectively intervene.
The spread between implied volatility on the Euro Stoxx 50 and S&P 500 was discussed with an observation being that Euro Stoxx 50 vol is cheap relative to S&P 500 vol. The idea is to find a way to be long Euro Stoxx 50 vol and short S&P 500 vol. I had a chance to speak to one of the presenters after the session and asked if this outlook also had a fundamental basis, that is that EU economic conditions are more at risk than the US. His feel was that is the case as well as there being a difference between volatilities.
The effectiveness of hedging with broad based index put options was discussed with a look at how often various puts are in the money at expiration. It was noted that over the last 10 years a 30 day ATM SPX Put would expire in the money 36% of the time. This means that it would have not value 64% of observations. However, when in the money the ATM put had a value that was twice as much as the starting market value. A similar study was run using Euro Stoxx 50 options and it was shown that a 90-day 5% OTM Put on the Euro Stoxx 50 expires in the money 22% of the time on average, when in the money, has a premium that is 3 times that of the initial price.
Rocky Fishman, Equity Derivatives Strategist from Deutsche Bank Securities and Andrew Warwick, Managing Director from Blackrock teamed up to discuss Hedging with VIX Option at CBOE’s Risk Management Conference in Ireland Tuesday.
They focused on evaluating VIX option strategies, not just from implementation to expiration, but also looking at the behavior of positions over a multi-week period. A comparison was made between SPX and VIX option hedging as well as looking at when it may be time to monetize a VIX hedge. They also took a look at using VIX ETPs for hedging purposes.
With respect to timing the monetization of a VIX hedge, the VIX reaction to the Brexit referendum was used as an example of how important taking profits on a VIX position can be. It was noted that in order for a VIX hedge to be effect the position needed to be exited either on Friday June 24th or Monday June 27th. After the 27th, only a position entered on the 23rd would have still proved profitable, and that profit went away the following day.
There was also a comparison between buying a VIX call option and taking a long position in a call spread. The pure long call outperforms call spreads in a severe volatility spike. Also, it was noted that out of the money call spreads need a strong quick shock to work.
Finally, three costs of having a VIX hedge were discussed. There is the negative carry that is associated with owning any option with time value. If a put is sold to fund a long call, we may be exposed to losses if there is a drop in VIX futures. Finally, if options are sold on another asset to pay for a VIX hedge there is always the possibility of experiencing losses on the short option position.
This week a new paper by Fund Evaluation Group (FEG) — Evaluating Options For Enhanced Risk-Adjusted Returns: CBOE Russell 2000 Option Benchmark Suite and Case Studies on Fund Use of Options (2016) – was released and presented at the Fifth Annual CBOE Risk Management Conference (RMC) Europe.
A link to the new 18-page paper is at www.cboe.com/benchmarks, and below in this blog are 6 of the 30 exhibits in the paper.
DESCRIPTIONS OF INDEXES ANALYZED
Stephen Crewe from Fulcrum Asset management and Dhvani Gupta from Barclays shared the presentation duties during a session titled Implementing Systematic Short Volatility Strategies at the 5th Annual European CBOE RMC this afternoon.
Dhvani Gupta started things off noting that the SPX Implied – Realized Volatility Premium has averaged 4.3% since January 1990 through present. She noted that short volatility exposure has benefits beyond traditional diversification techniques so she suggests substituting the equity risk premium with volatility exposure. She also spent time discussing the benefits of frequent trading to reduce path dependency as well as allowing for a more stable gamma profile.
Stephen Crewe followed up with a discussion that focused on the diversification benefits of short volatility positioning across asset classes. He noted that the correlation between the EuroStoxx 50 and S&P 500 is about 85% but the correlation of the volatility risk premium of options trading on those two indexes is around 72%. He also spent some time on different assets for example noting that the volatility risk premium for Natural Gas is correlated by only 2% with SPX volatility.
Daniel Danon from Assenagon Asset management and Nicolas Vanhoutteghem from Argentiere Capital teamed up for a discussion around Implementing Long Volatility Exposures at CBOE RMC in Ireland this afternoon.
Danon kicked things off with a discussion centering around creating an affordable volatility exposure. This is a topic that we could probably have a single full day conference discussing as the flexibility around how to gain long volatility exposure without suffering the costs often associated with this exposure. In the time allotted he was able to compared long put options, delta hedged positions, and using various long volatility structures. He then noted that relative value trades are a good method of financing long volatility exposure in order to hedge a portfolio.
Vanhoutteghem started his session off noting that 3 month SPX implied volatility is near the 15th percentile over the past 10 years. However, this does not mean that protection is cheap because realized volatility is at 6.5 or 6 volatility points below implied. The normal level is about 2 volatility points of premium to realized. The result is a high cost of carry and the goal is to determine how to minimize this cost of carry.
The first afternoon session at CBOE RMC Europe was a discussion titled Panel on Volatility-Based Investment Strategies. The panel moderator was Chris Limbach, Managing Director Investments, PGGM Institutional Business. The panelists were:
- Uri Geller, Co-Founder and CIO, Granite M.S.A LTD
- Roy Hoevenaars, PhD, Portfolio Manager, Blenheim Capital Management
- Fergus Taylor, Portfolio Manager, Arrowgrass Capital Partners
- Brendan Walsh, Multi Asset Fund Manager, Aviva Investors Global Services
Some themes that were touched on during the presentation included:
- The search for yield has resulted in some structured solutions due to the low interest rate environment
- It was noted that currency volatility has been an area of opportunity this year based on commodity price changes as well as political events
- At times there are selective opportunities to be long volatility – but the mean reverting nature of volatility makes long volatility trading tricky
- The creation and popularity of Weeklys has created many new opportunities
- In a world of low-yield the S&P 500 offers one of the few quality investments
- One panelist noted that VIX Weeklys are an instrument they turn to for long volatility positions
Rebecca Cheong from UBS led a discussion titled Cross Asset Dislocations and Market Signals. She also was the first of our presenters to utilize our instant poll app during her presentation. More on that in a moment…
Rebecca’s presentation was divided into three sections. She initially covered market dislocations noting that some are temporary and others are structural, with the latter often lasting longer. An example that we are probably all familiar with is the increase in SPX put skew that has accompanied the implementation of Dodd-Frank.
The presentation then moved on to discuss these dislocations and the use of them as market signals. Specifically, she noted disconnections between top down and bottom up risk drivers. For example, the cost of hedging an S&P 500 portfolio may be cheap while individual stock hedging costs may be expensive or EEM options may be cheap and options on individual emerging markets may be expensive. Eventually these dislocations should come back in line.
Finally, Rebecca asked several polling questions that the audience was able to answer using an app that conference participants were using. Her final question was which of the following has experienced the most growth over the last 5 years. Note the results in the graphic below.
Neither the average height of a six-year old boy or the growth of hedge fund assets under management were near the top. However, attendees were wrong to assume the growth of VIX ETPs or VIX Futures volume experienced higher growth than the assets under management in in Managed Risk Funds over the past five years.
The final session at CBOE’s Risk Management Conference in Europe today was a panel discussion that was titled Real Money: Institutional Liabilities and How Options Strategies Can Help. The moderator was Abhinandan Deb, Head of European Equity Derivatives Research, Bank of America Merrill Lynch. The panelists were:
- Jon Havice, President and Chief Investment Officer, DGV Solutions
- Michael Holliger, Portfolio Manager, Swiss Life Asset Management AG
- Dan Mikulskis, Head of DB Pensions, Redington, Ltd.
Before the discussion each panelist made about a 15 minute presentation.
Jon Havice led things off highlighting the types of liabilities that institutions are charged with matching. He notes that option strategies offer the ability to reduced downside exposure without reducing return expectations, although some upside participation will be sacrificed. He spent some of his presentation discussing how many pension funds are currently underfunded. He did note the CBOE Put Write Index (PUT) as a good example of a strategy that offers equity like returns with lower volatility of those returns. Finally, he demonstrated PUT performance in different market environments and noted that is many regimes PUT outperforms the S&P 500.
Michael Hollinger followed up discussing the pension system in Switzerland and what factors influence equity positioning at Swiss Life. Four factors that impact equity positioning are regulatory in the form of the Swiss Solvency Test, accounting treatment of investments, return expectations, and liability structure. He noted three different potential equity exposures: long the market, long market plus a put-spread collar, or long market plus owning a put.
Dan Mikulskis was the final presenter and he discussed the pension funding gap in the UK. He spent some time discussing different approaches to filling the gap and he noted that there are many more tools and methods to close the gap than have been available in the past.
A takeaway from this panel was that despite the headlines that look pretty dire with respect to unfunded liabilities. However, the situation may be manageable over time and the gap can be closed.
The second presentation on the first day of RMC featured a discussion titled Constructing / Deconstructing Volatility Risk Premia Strategies delivered by Roni Israelov from AQR Capital Management. This presentation centered around an article that appeared in the Financial Analysts Journal in 2015 titled Covered Calls Uncovered which may be found at www.aqr.com/library/journal-articles/covered-calls-uncovered
This presentation started out with a discussion of Covered Calls with the CBOE S&P 500 BuyWrite Index being used to demonstrate the type of returns associated with a systematic covered call program. It is noted that covered calls seek to offer equity-like returns with lower volatility.
Israelov breaks down the returns associated with covered calls into three parts: passive equity, short volatility, and equity timing. Specifically, he notes that a covered call includes equity timing and short volatility exposure and reduces passive equity exposure relative to the underlying equity index. He noted their approach to studying these returns may be applied to other strategies and that AQR has another study available focusing on equity index collars which is also available at www.aqr.com/library/journal-articles/risk-and-return-of-equity-index-collar-strategies
Some highlights from Israelov’s presentation include:
- The alpha from selling an at the money call comes from being short volatility
- A demonstration of how the timing bet associated with the at the money covered call grows and then resets
- Noting the potential performance of a strategy that eliminates the equity market timing risk component of a buy-write strategy which he refers to as a Risk-Managed Buy-Write Index
- He also noted that the beta for a risk managed strategy is much lower than a traditional buy write strategy when the market is under pressure
- He finished up with a preview of a forthcoming study that looks at covered call returns for 11 global equity indexes
The first session that kicked off the 5th Annual European version of CBOE’s Risk Management Conference involved a discussion titled New Developments in Options and Volatility-Based Benchmarks delivered by Bill Speth and Matt Moran.
Bill kicked things off talking about some current and pending strategy based indexes created by CBOE. The indexes discussed were:
- CBOE Russell 2000 Conditional BuyWrite Index
- CBOE S&P 500 Smile Index
- CBOE S&P 500 Buffer Protect Strategy Series
- CBOE S&P 500 Enhanced Growth Strategy Series
- CBOE SMA Large Cap Index
- CBOE Stabilis Index
A couple of these indexes are in the process of development and will be introduced in the next few weeks (Smile Index and Stabilis Index) so I’ll hold off talking about them in this space until that time.
In discussing the Russell 2000 Conditional BuyWrite Index he noted the strong absolute and risk adjusted returns. He noted the Buffer Protect and Enhanced Growth Series Indexes and discussed how Vest Financial is working with CBOE with respect to Target Outcome Indexes. Finally, he spent some time discussing the development of the SMA Large Cap Index in conjunction with Social Market Analytics.
Matt Moran followed Bill with a look at several recent studies that have covered CBOE strategy indexes. Matt started out showing a list of papers, most of which may be found at www.cboe.com/benchmarks
He highlighted PutWrite indexes that CBOE currently calculates and quotes
- CBOE S&P 500 PutWrite Index (PUT)
- CBOE Russell 2000 PutWrite Index (PUTR)
- CBOE S&P 500 One-Week PutWrite Index (WPUT)
- CBOE Russell 2000 One-Week PutWrite Index (WPTR)
Matt specifically highlighted results from a study that came out just a week ago from Wilshire which took a look at BXM, BXMD, CLLZ, PPUT, and PUT indexes.
- CBOE S&P 500 BuyWrite Index (BXM)
- CBOE S&P 500 30-Delta BuyWrite Index (BXMD)
- CBOE S&P 500 Zero-Cost Put Spread Collar Index (CLLZ)
- CBOE S&P 500 5% Put Protection Index (PPUT)
- CBOE S&P 500 PutWrite Index (PUT)
The study noted that on an absolute basis both PUT and BXMD outperform the total return of the S&P 500 over a 30-year period. One of the most interesting findings in the Wilshire study is that all five of the indexes in the study experienced a lower peak to trough drawdown than a buy and hold portfolio.
Another study discussed by Matt was conducted by Fund Evaluation Group which focused on Russell 2000 Index Option oriented strategies. This study noted that the CBOE Russell 2000 PutWrite Index (PUTR) has outperformed the Russell 2000 Index since 2001 with lower volatility than the Russell 2000. He also highlighted several other aspects on this study which is scheduled to be released in the very near future.
While the market may have ended last week on a sour note, a little pre-weekend profit-taking can’t entirely come as a surprise. Once traders learned on Wednesday the Federal Reserve wouldn’t be imposing a rate-hike this month, they celebrated in the form of a 1.7% advance that lasted all the way through Thursday’s close. Friday’s 0.6% lull didn’t even drag any of the major indices back below their most important technical levels.
Still, stocks could just as easily kick-start a pullback here as they could reignite the rally. They finished the week on the fence, and within sight of a breakdown and a breakout. Overall, the bulls look to have a bit of the edge here.
We’ll look at the stock market big picture in a moment, after a rundown of last week’s and this week’s most important economic news.
Last week wasn’t all that busy in terms of economic data. The biggie was of course Wednesday’s interest rate decision, and the Fed’s assessment of the current economic condition. The Federal Reserve is pleased with the economy, though doesn’t see it so strong that it needs to be cooled.
It was also a big week for real estate, and home constriction in particular. It wasn’t an especially encouraging week, however.
That data started out with August’s housing starts and building permits. Both fell from July’s levels, and fell short of estimates. Perhaps more alarming is how both seem to be slowing down in a much bigger way.
Housing Starts and Building Permits Chart
Source: Thomson Reuters
Existing home sales were also a disappointment, falling to a pace of 5.33 million versus expectations for a rise to a pace of 5.5 million. Limited inventory may continue to be holding sales of existing homes back.
Existing Home Sales, Inventory Chart
Source: Thomson Reuters
We won’t get an update on new home sales until this week. Inventory have been light there too, though it’s worth noting the weakness we’ve seen in terms of existing homes has largely been offset by the rise in purchases of new houses.
Everything else is on the following grid: