CBOE Global Volatility Feature for Options Profits

This complimentary article from Options Profits was originally published on January 3 at 8:59am EST. Don't risk missing over 40 options trade ideas every week and exclusive commentary from over 10 experts. Click here for more information.

Russell Rhoads is an instructor with The Options Institute at the Chicago Board Options Exchange. He is a financial author and editor having contributed to multiple magazines and edited several books for Wiley publishing. In 2008 he wrote Candlestick Charting For Dummies and is the author of Option Spread Trading: A Comprehensive Guide to Strategies and Tactics. Russell also wrote Trading VIX Derivatives: Trading and Hedging Strategies using VIX Futures, Options and Exchange-Traded Notes. In addition to his duties for the CBOE, he instructs a graduate level options course at the University of Illinois - Chicago and acts as an instructor for the Options Industry Council.

Volatility as an asset class continues to gain acceptance among money managers and the trading of volatility continues to grow. For over seven years traders have been able to speculate on US market volatility using derivative instruments that are based on the VIX. Now traders will have the opportunity to also trade volatility on global emerging markets.

Next Monday, January 9, the CBOE Futures exchange is going to start trading a new volatility-related futures contract. These contracts will be based on the CBOE Emerging Markets ETF Volatility Index (VXEEM). The VXEEM was rolled out in the first quarter of 2011 along with several other alternative volatility indexes. This index uses the same methodology as the widely recognized CBOE Volatility Index (VIX). However, the VIX is calculated using applying S&P 500 index option prices while the VXEEM is calculated using option prices on the iShares MSCI Emerging Markets Index (EEM) exchange traded fund. The option market on the EEM is very liquid. Recently, January open interest was well over 2,000,000 contracts.

The EEM ETF is one of the most convenient methods for US investors to gain investment exposure to emerging markets. The goal of the fund is to match investment results in the MSCI Emerging Markets Index (MFXE). This results in the VXEEM being a good proxy for expected volatility of emerging markets.

The EEM was introduced in the first half of 2003. The performance of this ETF has been right in line with the MXFE. On a monthly performance basis the EEM and MXFE have a correlation of over 97%. In fact, the EEM has slightly outperformed the underlying index from the EEM's inception in April 2003 to the end of 2011. The chart below depicts a $100 investment directly in the MXFE index and $100 invested in the EEM fund would have performed since inception of the EEM.