Russell Rhoads - Trading VIX Derivatives

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Copyright 2011 by Russell Rhoads. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Rhoads, Russell.
Trading VIX derivatives : trading and hedging strategies using VIX futures, options, and exchange-traded notes / Russell Rhoads.
p. cm. (Wiley trading ; 503)
Includes bibliographical references and index.
ISBN 978-0-470-93308-4 (hardback); ISBN 978-1-118-11846-7 (ebk);
ISBN 978-1-118-11847-4 (ebk); ISBN 978-1-118-11848-1 (ebk)
1. Derivative securities. 2. Hedging (Finance) 3. Options (Finance) I. Title.
HG6024.A3R523 2011
332.6457dc22
2011014331

Dedicated to Merribeth, who holds down the fort.

Preface

The current level of the CBOE Volatility Index, or VIX, is part of the litany of information thrown out at a rapid pace on morning business programs. In times of extreme market moves, the VIX gets a bit more attention and possibly a little explanation. That explanation is often that it is a fear index. Needless to say, the VIX is much more than an index of fear in the stock market.

The VIX emerged from academic work in the early 1990s as a method of determining a consistent level of implied volatility of option contracts trading on the S&P 100 (OEX) Index at the Chicago Board Options Exchange. For almost a decade, this measure was a side note of market activity.

Then, in the early part of the 2000s, the formula was updated to encompass more option contracts and the focus shifted from the S&P 100 to the S&P 500 index. This update, to include more contracts and focus on the S&P 500, was in preparation to offer derivative contracts on volatility.

Futures and then option contracts were developed by the CBOE to allow investors the ability to capitalize on an outlook for market volatility. These contracts witnessed steady growth until the second half of 2008, when, with an explosion in implied volatility, the marketplace realized the benefits of volatility as a diversification tool.

Other exchanges have taken notice of the success of VIX futures and options and have developed their own volatility indexes and derivative products. Volatility indexes and derivatives on gold, oil, currencies, and even soybeans are now calculated and traded by a variety of exchanges.

This book is divided into two sections. The first half of the book is a description and overview of the variety of volatility-related indexes and products currently available. The unique features of many of the derivative contracts are based on implied volatility, and these are touched on throughout the first section. Some of the confusion that novice traders encounter when considering trading VIX products is addressed, along with instructions on how to interpret a variety of indexes.

The second half of this book is devoted to the uses of volatility-related indexes and products. Methods for speculating on the direction of the overall market or just volatility are addressed. Using volatility derivatives as a tool for hedging traditional portfolios is discussed. Also, the emergence of volatility indexes and trading products as forecasting tools is discussed.

Volatility as an asset class and trading tool is a rapidly growing area in the markets. While writing this book, dozens of new indexes and derivative products based on implied volatility were introduced. Trying to keep up with all of them is nearly impossible, and if I'd tried, this book may never have made it to your hands.

Acknowledgments

There are many people throughout my life who have allowed me to reach the point where I look forward to going to work and truly enjoy what I get to do professionally day in and day out.

The primary person is my wife, Merribeth Rhoads. Her support and patience have been a key contribution to the completion of this book in a timely manner.