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Trading VIX Futures and Options–Russell Rhoads, CFA–Instructor – The Options Institute 2010 Chicago Board Options Exchange, Incorporated. All rights reserved.

CBOE DisclaimerOptions and futures involve risks and are not suitable for all investors. Prior to buying orselling options, an investor must receive a copy of Characteristics and Risks of StandardizedOptions. Copies may be obtained by contacting your broker by calling 1-888-OPTIONS, or atwww.theocc.com. In order to simplify the computations, commissions, fees, margin interestand taxes have not been included in the examples used in these materials. These costs willimpact the outcome of all securities and futures transactions and must be considered prior toentering into any transactions. Investors should consult their tax advisor about any potentialtax consequences. The information in this presentation, including any strategies discussed,is strictly for illustrative and educational purposes only and is not to be construed as anendorsement, recommendation, or solicitation to buy or sell securities or futures. Supportingdocumentation for any claims, comparisons, recommendations, statistics, or other technicaldata, will be supplied upon request. Past performance is not a guarantee of futureresults. CBOE , Chicago Board Options Exchange , CBOE Volatility Index , VIX and TheOptions Institute Logo are registered trademarks and SPX is a servicemark of CBOE. S&P ,and S&P 500 are registered trademarks of the McGraw-Hill Companies, Inc. and arelicensed for use by CBOE. Standard & Poor's does not promote, market, sell or endorse anyproduct based upon its indices. iPath, iPath ETNs and the iPath logo are registeredtrademarks of Barclays Bank, PLC.Copyright 2010 Chicago Board Options Exchange, Incorporated. All rights reserved.CHICAGO BOARD OPTIONS EXCHANGE

VIX Futures / Options – Outline VIX Index– History– Defined - Calculation VIX Futures– Contract Specs– Settlement– Spreads VIX Options– Contract Specs– Settlement– UnderlyingCHICAGO BOARD OPTIONS EXCHANGE VIX ETN’s– VXX & VXZ– Options on VXX & VXZ VIX and S&P 500 Relationship– VIX Diversification Benefits– Short Term Relationships Summary / Q&A

VIX IndexA Brief History of the VIX –1993 – VIX introduced in a paper.2003 – VIX calculation changed.2004 – futures contracts introduced.2006 – options on VIX begin trading.2008 – binary options on the VIX.2009 – mini-VIX futures introduced.2009 – ETNs on VIX introduced.CHICAGO BOARD OPTIONS EXCHANGE

VIX IndexThe VIX –CBOE Volatility Index .Measures S&P 500 implied volatility.Based on S&P 500 Option bid/ask quotes.Uses the nearby options with at least 8days until expiration.Has been promoted as a ‘fear index’ bythe business media.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesVIX Futures Value is 1000 x the level of the VIX Index. Trade the next 7 months of expiration. Expire on Wednesday 30 days beforecorresponding S&P 500 option expiration. Have very unique characteristics relative toother financial futures.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesMini VIX Futures Value is 100 times the VIX Index. Trade the next 3 months of expiration. Expire on Wednesday 30 days beforecorresponding SPX option expiration. Have very unique characteristics relativeto other financial futures.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesPricing –VIX FutureJune VIX – VXM0 @ 26.90 26,900.Minimum price move .05 or 50. /- 1.00 price change /- 1000.Mini-VIXJune VIX – VMM0 @ 26.90 2,690.Minimum price move .05 or 5. /- 1.00 price change /- 100.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesExpiration Months –VIX FuturesNext 7 MonthsCurrently – Jul, Aug, Sep, Oct, Nov, Dec,JanMini-VIXNext 3 MonthsCurrently – Jul, Aug, SepCHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesUnique Features –Pricing is anticipatory, no ‘cost of carry’.Future price reflects market opinion of thefuture direction of the spot VIX Index.At times the VIX future price is higher thanthe index and at times it is lower.CHICAGO BOARD OPTIONS EXCHANGE

VIX Index vs. Front Month FutureDaily Chart – 6/1/2007 – 78/24/079/7/079/21/07Data Source BloombergCHICAGO BOARD OPTIONS EXCHANGE

VIX Index vs. Front Month FutureDaily Chart – 4/1/2009 – 96/24/097/8/097/22/09Data Source BloombergCHICAGO BOARD OPTIONS EXCHANGE

VIX Index vs. June FutureDaily Chart – 3/1/2010 - HICAGO BOARD OPTIONS EXCHANGE3/29/104/12/104/26/105/10/105/24/10Data Source Bloomberg

VIX Index vs. June VIX5 Minute Chart – 5/13/201027IndexFuture2625249:3510:35CHICAGO BOARD OPTIONS EXCHANGE11:3512:3513:3514:3515:35Data Source Bloomberg

VIX Index vs. June VIX5 Minute Chart – 5/17/201036IndexFuture34323028269:3510:35CHICAGO BOARD OPTIONS EXCHANGE11:3512:3513:3514:3515:35Data Source Bloomberg

VIX FuturesExpiration –Futures expire 30 days before the nextmonth’s normal option expiration.Example – July 2010 VIX FuturesExpire Wednesday July 21.Option Expiration is August 20.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesSettlement Pricing –VIX futures are AM settlement with aspecial calculation of the VIX Index takingplace the morning after the end of tradingfor a futures contract.This is known as the Special OpeningQuotation.CHICAGO BOARD OPTIONS EXCHANGE

VIX FuturesSpecial Opening Quotation (SOQ) –This is a unique VIX index quote thatinvolves only actual S&P 500 optiontrades. The regular VIX Index calculationuses the mid-point between bids andoffers.The symbol for the SOQ is VRO.CHICAGO BOARD OPTIONS EXCHANGE

Settlement History - eJune 201026.1125.870.2425.850.25May 201034.5333.550.9832.701.83Apr 201015.8015.730.0716.00(0.20)Mar 201016.6817.69(1.01)17.45(0.77)Feb 201022.5022.250.2522.60(0.10)Jan 201018.8717.581.2917.851.02Source – www.cfe.cboe.comCHICAGO BOARD OPTIONS EXCHANGE

Settlement History - eDec 200920.8421.50(0.66)21.35(0.51)Nov 200922.5422.410.1322.55(0.01)Oct 200920.8220.90(0.08)21.10(0.28)Sep 200923.6423.420.2223.500.14Aug 200928.7626.182.5826.352.41Jul 200923.4823.87(0.39)24.05(0.57)Jun 200931.0332.68(1.65)31.85(0.82)May 200927.0428.80(1.76)28.50(1.46)Apr 200938.2037.670.5337.850.35Mar 200940.6240.80(0.18)40.050.57Feb 200948.4048.66(0.26)48.000.40Jan 200949.8856.65(6.77)57.90(8.02)CHICAGO BOARD OPTIONS EXCHANGESource – www.cfe.cboe.com

Settlement History - eDec 200851.2952.37(1.08)52.44(1.15)Nov 200867.2267.64(0.42)67.040.18Oct 200863.0453.119.9352.8010.24Sep 200831.5430.301.2429.681.86Aug 200820.8321.28(0.45)21.00(0.17)Jul 200828.4028.54(0.14)28.43(0.03)Jun 200821.5421.130.4121.050.49May 200817.1617.58(0.42)17.37(0.21)Apr 200821.7822.78(1.00)22.87(1.09)Mar 200825.6725.79(0.12)25.95(0.28)Feb 200825.5125.020.4926.07(0.56)Jan 200824.1823.340.8424.040.14CHICAGO BOARD OPTIONS EXCHANGESource – www.cfe.cboe.com

Settlement History - eDec 200722.0822.64(0.56)22.55(0.47)Nov 200726.7024.881.8225.081.62Oct 200718.3320.02(1.69)20.03(1.70)Sep 200720.2920.35(0.06)20.180.11Aug 200725.0525.25(0.20)25.24(0.19)Jul 200716.8715.631.2415.571.30Jun 200713.0112.850.1612.880.13May 200713.6314.01(0.38)13.96(0.33)Apr 200712.0312.14(0.11)11.870.16Mar 200712.9813.27(0.29)13.06(0.08)Feb 20079.9510.34(0.39)10.43(0.48)Jan 200710.7110.74(0.03)10.590.12CHICAGO BOARD OPTIONS EXCHANGESource – www.cfe.cboe.com

VIX Spreads – 5/20/2010 – 5 11:3012:3013:3014:30Data Source BloombergCHICAGO BOARD OPTIONS EXCHANGE

VIX Spreads – 5/26/2010 – 5 012:3013:3014:30Data Source BloombergCHICAGO BOARD OPTIONS EXCHANGE

Spreads – 5/27/2010 – 5 Min33VXM0VXN0VXQ0VXU03242313301298:309:30CHICAGO BOARD OPTIONS EXCHANGE10:3011:3012:3013:3014:30Data Source Bloomberg

Spreads – Daily 5/3 – 5/273634VXM0VXN0VXQ0VXU032305/20285/26 – 5/272624225/3/10CHICAGO BOARD OPTIONS EXCHANGE5/9/105/15/105/21/105/27/10Data Source Bloomberg

VIX Options Introduced in 2006 Caught on very quickly as a method of trading volatilityCurrently second most actively tradedindex option series at the CBOEHave growing institutional following ashedging vehicleCHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsCharacteristics European Style Wednesday Settlement Unusual Pricing Opening Price QuotationCHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsEuropean Style –European options are only allowed to beexercised on expiration.VIX options are cash settled at expiration.CHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsWednesday Settlement –Just like the VIX futures contracts, VIXoptions expire on the Wednesday 30 daysbefore equity option expiration.CHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsOpening Price Quotation –VIX Options are settled using the SpecialOpening Quotation on the morningfollowing the last trading day for thoseoptions. This is identical to the settlementprocess for the VIX futures.CHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsUnusual Pricing –It is not uncommon for VIX options to appearto be cheap or expensive when using theVIX Index as the underlying.When pricing options, the proper underlyinginstrument should be the corresponding VIXfuture price.CHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsUnusual Pricing –VIX Index @ 32.00VIX August 30.00 Call @ 1.25VIX August Future @ 30.50CHICAGO BOARD OPTIONS EXCHANGE

VIX OptionsUnusual Pricing –VIX Index @ 27.50VIX July 30.00 Put @ 1.50VIX July Future @ 29.00CHICAGO BOARD OPTIONS EXCHANGE

VIX Options - Open Interest4,000,000December 2009July 20093,500,0003,000,0002,500,000April GO BOARD OPTIONS Source – www.cboe.com

VIX ETNsVIX Exchange Traded Notes What is an ETN?Short Term Volatility - VXXIntermediate Term Volatility - VXZCharacteristics of these ETNsCHICAGO BOARD OPTIONS EXCHANGE

VIX ETNsWhat is an ETN?ETN stands for Exchange Traded Note, itis an unsecured, unsubordinated debtsecurity. They are created to replicatereturns on an index minus fees. Thetrading in ETN’s is very similar to that inETF’s (Exchange Traded Funds).CHICAGO BOARD OPTIONS EXCHANGE

VIX ETNs iPath S&P 500 VIX Short-Term FuturesETN (VXX) –Gives investors exposure to a daily rollinglong position in the first and second monthVIX futures contracts.CHICAGO BOARD OPTIONS EXCHANGE

VIX ETNsiPath S&P 500 VIX Mid-Term Futures ETN(VXZ) –Gives investors exposure to a daily rollinglong position in the fourth through seventhmonth VIX futures contracts.CHICAGO BOARD OPTIONS EXCHANGE

VIX ETNsCharacteristics – Introduced in Q1 2009 Exchange traded on the NYSE Have a negative correlation to S&P 500index returns Backed by Barclays BankCHICAGO BOARD OPTIONS EXCHANGE

VIX ETNsVXX – Average Daily 0000150000001000000050000000Feb 09CHICAGO BOARD OPTIONS EXCHANGEMay 09Aug 09Nov 09Feb 10May 10

VIX ETNsVXZ – Average Daily 00001000000Feb 09CHICAGO BOARD OPTIONS EXCHANGEMay 09Aug 09Nov 09Feb 10May 10

VIX ETNsVXX / VXZ Options – May 28 – first day of trading at CBOE First Day Volume for VXX Options 20,000 First Day Volume for VXZ Options 1,500 Options on March Cycle– Current months - July, August, September,& December Dollar StrikesCHICAGO BOARD OPTIONS EXCHANGE

VIX DiversificationUniversity of Massachusetts Paper – Studied the 2008 market and thediversification benefits of VIX futures oroptions. Compared a variety of portfolios andcombined exposure to the VIX. Results showed return and diversificationbenefits of including the VIX in a portfolio.CHICAGO BOARD OPTIONS EXCHANGE

VIX DiversificationUniversity of Massachusetts Paper –Full study available on the CBOE CAGO BOARD OPTIONS EXCHANGE

VIX IndexCommon Question –Why does the VIX only seem to goup when the S&P 500 goes down?orWhy doesn’t the VIX spike whenthe S&P 500 runs up rapidly?CHICAGO BOARD OPTIONS EXCHANGE

VIX IndexCommon Answers –Put Call ParityPeople and PanicCHICAGO BOARD OPTIONS EXCHANGE

VIX vs. SPX10 Worst S&P 500 Days – 1/1/2007 – 5/14/2010SPXVIX IndexVIX /5/2008-5.27%14.31%8.12%CHICAGO BOARD OPTIONS EXCHANGEData Source Bloomberg

VIX vs. AGO BOARD OPTIONS /08Data Source Bloomberg

VIX vs. SPX – 5/6/2010 – 5 Min118042.50116038.50114034.50S&P 500VIX Index112030.50110026.50108022.508:309:30CHICAGO BOARD OPTIONS EXCHANGE10:3011:3012:3013:3014:30Data Source Bloomberg