Schaeffer's Trading Floor Blog

Happy Birthday, VIX Futures!

A look back at the 2004 launch of VIX futures

by 3/26/2014 7:10 AM
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Do you remember where you were 10 years ago today? If you were a CBOE trader back then, that date might ring a bell. It marked the birth of tradable CBOE Volatility Index (VIX) futures!

Ten years ago at CBOE, on March 25, 2004, on the eve of the launch of futures on the CBOE Volatility Index® (VIX®), presentations on Volatility and Enhanced Returns were delivered by a 4-person panel comprised of Joanne Hill, Izzy Nelken, Gary Lahey, and Jon Najarian. There was quite a bit of excitement in the room as the presentations were delivered, as in previous years investors had requested a tradable version of the well-known and powerful VIX Index, but there also was uncertainty as to how the new VIX futures might be priced and hedged. At the time some experts had suggested that the potential for success was greater for variance futures than for VIX futures.

I started financial writing about 10 years ago, fortunately on a site that no longer exists. I believe it was called Street Insight … it was behind a pay wall at another major financial news website. I'm guessing I doubted that VIX futures would thrive. I mean … c'mon … VIX is a statistic. The futures are cash settled, so it's not like you could go "long" VIX when the actual VIX looked subjectively low and then hold it until it inevitably rallied. Why not just use puts to hedge downside like we've all done forever? When you buy index puts, you're either explicitly or implicitly going long volatility anyway. Why do we need another way to make a bet we can already easily make?

And as they mention above, how do you hedge? Say you go short a VIX future or calls on a VIX future. I can't buy "spot" VIX against it; the best I can do is buy a string of index options and actively hedge the long volatility. But that's essentially buying realized volatility, not implied volatility. And I can't buy one future against another. I mean, I can, it's a hedge in the general sense, but it's not locked in any way, shape or form. Just spend five minutes on looking at term structures at random dates, and you'll see the relationships between cycles are extraordinarily varied.

Boy, was hypothetical me wrong! I don't remember if I actually wrote or thought that at the time … I'm guessing that was my opinion, though.

Needless to say, VIX futures have thrived.

Over the past decade the total trading volume for VIX futures has surpassed 95 million contracts, and the VIX futures average daily volume rose from 4,543 in 2009 to more than207,000 so far in 2014.

Given all the offshoots that we have now, like iPath S&P 500 VIX Short-Term Futures ETN (VXX), VelocityShares Daily 2x VIX Short-Term ETN (TVIX) ("2x VXX"), VelocityShares Daily Inverse Short-Term ETN (XIV) ("inverse VIX"), and many others, VIX futures feel downright tame and safe. But there's still no perfect way to hedge. And that often makes life difficult for the "locals" who take the other side of VIX futures and options order flow. Almost all orders are "long" VIX trades, so there's always exposure somewhere in the system to a sudden VIX pop. And that has the potential to spiral a bit as trapped traders scramble to cover.

There was also the issue of uninformed public traders not realizing that when they buy VIX calls, they're buying calls on VIX futures and not "cash" VIX. In the early days, I'd get emails about that a couple of times a week. Now I don't even remember the last time someone asked about that. Maybe an occasional Twitter complaint about VXX not lifting when it "should," but that's about it.

So anyways, happy birthday VIX Futures! If you're in Chicago and went to help "celebrate," the CBOE is having a panel discussion after the close tomorrow.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.

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