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VIX: Quarterly Review

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**Special Feature from the CBOE's Options Institute**

Russell Rhoads, CFA 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.

The CBOE Volatility Index (VIX) dropped about 30% in the first quarter as the S&P 500 started out 2013 with a 10% rally that left many market participants scratching their heads. Typically VIX is reported as a headline number, but the real story in any market is where people are putting money to work. For VIX that would be VIX options, VIX futures, and VIX exchange traded products.

Coming into the year the markets had just avoided the dreaded 'fiscal cliff'. Unlike James Deans' unlucky foe in Rebel Without a Cause our leaders in Washington, DC were able to avoid catastrophe and did not take us over the fiscal cliff. Since this 'non-event' had just been avoided VIX ended 2013 at an elevated level of 18.02. Note the chart below that compares the VIX curves from December 31, 2012 and March 28, 2013. VIX was at 18.02, but the January VIX futures contract closed the day at 17.70. This small discount of the futures relative to the index was an indication of things to come for the first quarter of 2013.

The quarter closed with VIX at 12.70 and the chart of the futures curve back to what is considered a normal shape. The April and May futures are at a little more premium than the front month futures were in 2013, this can be attributed to the second quarter popping up with some volatility surprises over the past few years. It could also be attributed to the perpetual belief in the old Wall Street saying, "Sell in May". Say something often enough and people start to believe it.

Historically in the VIX option market there would be high open interest in out-of-the-money calls -- options with a 30 or even 40 handle. Since we have experienced a pretty low VIX over the past few months that sort of activity has gravitated toward much lower strikes. For example the biggest open interest for April VIX calls is in the VIX Apr 20 contract with the VIX Apr 17s coming in a close second. This can be a good indication of where volatility traders think VIX will go on any reaction to a drop in the S&P 500. Instead of the 30s, or beyond, traders are looking for any move in VIX to be to the low-to-mid 20s at best.

Finally, the table below compares VIX activity in first quarter of 2013 to each year from 2007 to 2012. Note so far in 2013 the range has been much tighter than previous years. Many market participants have been comparing this year to 2007. Note the range in 2007 widened out before the year was over and VIX managed to reach the low 30s.

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