10 Key Features of the VIX Index and New Mini VIX Futures (VXM)
By Matt Moran, Director, Institutional Product Advancement at Cboe
Cboe Futures Exchange (CFE®) launched trading in Mini Cboe Volatility Index® futures (VXMSM) on Monday, August 10. The increased volatility in 2020 amplified interest in the Cboe Volatility Index (VIX®) and related products, driving demand for a new addition to the VIX Index suite. We’ve compiled a list of features that may help investors better understand the VIX Index and the new Cboe Mini VIX futures.
Before reading further, it’s important to note:
- Mini VIX™ futures are complicated financial products that are suitable only for sophisticated market participants.
- Mini VIX futures involve the risk of loss, which can be substantial and can exceed the amount of money deposited for the futures position.
- Market participants should put at risk only funds that they can afford to lose without affecting their lifestyles.
- Before transacting in Mini VIX futures, market participants should fully inform themselves about the characteristics and risks of Mini VIX futures, including in particular those described below. Mini VIX futures market participants also should make sure they understand the product specifications and the methodologies for calculating the underlying VIX® Index and the settlement values for Mini VIX futures.
1. $100 Multiplier — For Both Mini VIX Futures and VIX Options
Mini VIX futures will be structured like the standard VIX futures contract, but will feature a $100 multiplier, making them one-tenth the size of the standard VIX futures contract. The smaller notional value of the Mini VIX futures contract is designed to provide additional flexibility in volatility risk management and greater precision when allocating among smaller, managed accounts, which is expected to appeal to a broad set of market participants, including Commodity Trading Advisors (CTAs), Futures Commission Merchants (FCMs), proprietary trading firms and sophisticated investors. Both the CFTC-regulated Mini VIX futures and the SEC-regulated VIX options have $100 multipliers. Investors who like to trade and spread both contracts, may find utility in the Cboe Capped VIX Premium Strategy Index (VPN), which sells VIX futures and buys VIX call options.
2. Around-the-Clock Trading Hours
Mini VIX futures will have the same global trading hours as VIX futures, providing access to investors when they seek it. Past unexpected events, such as the Brexit vote and the 2016 U.S. election, had a significant impact on both the prices and volume for VIX futures during U.S. overnight hours, highlighting the importance of Cboe’s global trading hours. Regular trading hours for Mini VIX futures will be Monday through Friday from 8:30 a.m. CT to 3:15 p.m. CT. Global trading hours for Mini VIX futures will be on business days Monday through Friday, from 5:00 p.m. (previous day) to 8:30 a.m. CT and 3:30 p.m. CT to 4:00 p.m. CT. Trading hours for an expiring Mini VIX futures contract will end at 8:00 a.m. CT on its final settlement date.
3. Higher Volatility in 2020
The long-term average for daily closing values for the VIX Index is 19.4 (for the 7,701 trading days from January 2, 1990 through July 24, 2020), but market reaction to the COVID-19 pandemic has triggered higher volatility and more interest in volatility management tools in recent months.
- The daily closing value for the VIX Index was above 24 for the 107 trading days between February 24 and July 24, well above the long-term average.
- The average daily closing price of the VIX Index in the second quarter of 2020 was 34.5, the highest value for any quarter in more than a decade.
- The VIX Index had an all-time high daily closing value of 82.69 on March 16, 2020, the Monday after the U.S. president declared the coronavirus pandemic a national emergency.
4. Negative Correlations, Convexity and Big Price Movements
The daily returns of the VIX Index have negative correlation with the S&P 500® (SPX®). The correlation has been negative 0.70 since the inception of the VIX Index data history in January 1990, as shown in the chart above. The correlation can become even more negative in volatile time periods, reaching negative 0.84 in 2008 and negative 0.73 so far in 2020 (through July 23). Investments that have low or negative correlations may appeal to investors who are exploring the possibilities of diversifying their portfolios in order to mitigate the risk of large damaging drawdowns for their overall portfolios. The VIX Index rose more than 25% on each of the five days since 1990 that the S&P 500 Index fell by more than 8%, as shown in the table below. More information about negative correlations, convexity and big price movements is available in Table 1 of a new VIX Index publication by the CFA Institute Research Foundation, and on page 5 of Cboe’s product guide on Futures and Options on the VIX Index.
5. Responsiveness of VIX Index And VIX Futures
VIX futures with near-term expirations have tended to be much more sensitive to changes in the VIX Index than VIX futures with long-term expirations. As shown in the chart below, the daily closing high values in March 2020 were 82.69 for the VIX Index and 70.475 for the April VIX futures. In comparison, the daily closing high value for October 2020 VIX futures was 34.125, reflecting the market’s pricing for expected 30-day volatility in mid-October.
The chart below shows that the beta to the VIX Index for VIX futures with four days to expiration has been about 0.7, but for VIX futures with 90 days to expiration, the beta to the VIX Index has been about 0.28.
6. In Contango and in Backwardation in 2020
The concepts of contango (when longer-dated futures are priced higher than short-dated futures and the spot value) and backwardation (when longer-dated futures are priced lower than short-dated futures and the spot value) can impact the potential for profitability for investors who hold futures on commodities and on the VIX Index. The chart below shows that the VIX Index was in contango on February 19 when it closed at 14.38, and it was in backwardation on March 16 when it closed at 82.69 (its all-time high). According to research by the CFA Institute Research Foundation, the VIX Index was in contango on about 80% of the days between 2007 and 2019. As detailed below, contango has the potential to provide a headwind for futures buyers and a tailwind for futures sellers (as long as the VIX Index does not rise sharply).
7. VIX Term Structure and Hedging The 2020 Election And COVID Risk
The VIX term structure as of July 2020 is quite thought-provoking. The chart below shows that the VIX Index closed at 25.84 for the end-of-week prices on July 24, while the VIX October futures — which can be used as a hedge against volatility surges around the November 3 U.S. election — settled at 32.52, higher than any other VIX futures on the chart.
The December, January and February, futures were all priced below 29.1. The lower prices for the VIX futures expiring in early 2021 may indicate that some investors may be optimistic that there may be a vaccine for COVID-19 in early 2021, delivering a recovering worldwide economy that might help dampen market volatility in 2021. There is a wide variety of potential calendar spreading opportunities for traders depending on expectations for implied volatility.
8. Buying Strategies for Mini VIX Futures with Potential Diversification Benefits
Mini VIX futures-buying strategies have potential to appeal to traders and investors who want to diversify their portfolios and are concerned about potential drops in stock index values and surges in volatility.
Professor Edward Szado explores how a hypothetical systematic VIX futures-buying strategy might have performed in 2008 and other past years in two research papers. Both Professor Szado’s 2-page and 54-page research papers include detailed portfolio performance analyses.
Investors can also examine the S&P 500 VIX Mid-term Futures Index (SPVIXMTR), which buys a combination of VIX futures positions in order to reflect the expectations of the VIX Index level in 5 months. Some of the VIX futures are rolled daily in order to maintain a constant average weighted five-month term.
The chart below show that the index rose 66% in March 2020, and 44% in October 2008 — two months in which the S&P 500 Index fell by more than 12%. Although the S&P 500 VIX Mid-term Futures Index has had some large upside moves in volatile months, the annualized return for the index has been about negative 9.0% since January 2006. Meanwhile, the VIX Index was in contango most months. Because of contango, some experts avoid recommending large, long-term allocations to volatility-futures-buying strategies. For risk-averse investors, the allocation of a small part of the portfolio to the buying of VIX futures or Mini VIX futures may have the potential to provide diversification benefits.
9. Selling Strategies for Mini VIX Futures
Knowing that the VIX Index has been primarily in contango, some investors may explore strategies that engage in systematic selling of Mini VIX futures, but investors should be aware of the downside risks of these strategies if there is a quick, big surge in VIX Index and Mini VIX futures values. It’s worth noting that the VIX Index has risen more than 50% on multiple trading days.
The Cboe VIX Capped Premium Strategy Index (VPN) is a benchmark index that attempts to mitigate downside risks of VIX-futures-selling strategies by tracking a hypothetical strategy that sells VIX futures. The index also holds cash and buys VIX call options with the goal of mitigating extreme downside risk. The metrics table below presents a 16-year analysis and shows that the VPN Index had the least severe maximum drawdown, the lowest beta and highest alpha of the four benchmark indices analyzed. Learn more in Professor Edward Szado’s research paper, Selling VIX® Futures and Options for Portfolio Return Enhancement.
10. More Information
The smaller notional value of the Mini VIX futures contract is designed to provide additional around-the-clock flexibility in volatility risk management and diversification strategies and greater precision when allocating among smaller managed accounts.
The links below may be helpful to traders and investors who are exploring the VIX Index and possible use of Mini VIX futures.
- Cboe Mini VIX Futures (VXM) — Contract Specifications and CFE Launch TradeDesk Notice
- Historical Data for VIX Index and for VIX Futures
- Research Papers published by S&P Dow Jones Indices, CFA Institute Research Foundation, Professor Edward Szado, Asset Consulting Group
- Cboe’s Futures and Options on the VIX Index Fact Sheet
Underlying Index: Mini VIX futures are based on the VIX®, which is a financial benchmark designed to be a market estimate of expected volatility of the S&P 500®. The VIX Index is calculated by using the midpoint of quotes of certain S&P 500 Index options. (More information on how the VIX Index is calculated is available here and here.)
Not Buy and Hold Investment: Mini VIX futures are not suitable to buy and hold because:
- On their settlement date, Mini VIX futures convert into a right to receive or an obligation to pay cash.
- The VIX Index generally tends to revert to or near its long-term average, rather than increase or decrease over the long-term.
Volatility: The VIX Index is subject to greater percentage swings in a short period of time than is typical for stocks or stock indices, including the S&P 500 Index.
Expected Relationships: Expected relationships with other financial indicators or products may not hold. In particular:
- Although the VIX Index tends to be negatively correlated with the S&P 500 Index, such that one tends to move upward when the other moves downward and vice versa, that relationship is not always maintained.
- The prices for the nearest expiration of Mini VIX futures tend to move in relationship with movements in the VIX Index. However, this relationship may be undercut, depending on, for example, the amount of time to expiration for the Mini VIX futures contract and on supply and demand in the market for those futures.
- Mini VIX futures contracts trade separately from regular-sized VIX futures, so the prices and quotations for Mini VIX futures and regular-sized VIX futures may differ because of, for example, possible differences in the liquidity of those markets.
Final Settlement Value: The method for calculating the final settlement value of mini VIX futures is different from the method for calculating the VIX Index at times other than settlement, so there can be a divergence between the final settlement value of mini VIX futures and the VIX Index value immediately before or after settlement. (More information is available here and here.
Trademarks: Cboe®, Cboe Global Markets®, CFE®, Cboe Volatility Index®, and VIX® are registered trademarks and Cboe Futures Exchange™ and Mini VIX™ are service marks of Cboe Exchange, Inc. or its affiliates. Standard & Poor’s®, S&P 500®, and SPX® are registered trademarks of Standard and Poor’s Financial Services, LLC, and have been licensed for use by Cboe Exchange, Inc. All other trademarks and service marks are the property of their respective owners.
The information in this article is provided for general education and information purposes only. No statement(s) within this article should be construed as a recommendation to buy or sell a security or futures contract, or to provide investment advice. Supporting documentation for any claims, comparisons, statistics or other technical data in this article is available by contacting Cboe Global Markets at www.cboe.com/Contact.
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