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March 1, 2013

To the Contrary

By Peter Chapman

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  • To the Contrary

The U.S. economy is on the mend. The European debt crisis is under control. The financial crisis of 2008 is receding into memory. Volatility is tamed. And yet derivatives based on the Chicago Board Options Exchange Volatility Index have never been more popular.

Last year, volume in futures and options based on the VIX reached new highs. From a daily average of 389,000 contracts in 2011, VIX options rose 14 percent to 443,000 contracts in 2012, according to data from the Chicago Board Options Exchange, where the contract trades. That's more than triple the level of 2009.

Growth in VIX futures has been even more spectacular. From an average of 48,000 contracts per day in 2011, volume in VIX futures nearly doubled last year to 95,000 contracts, according to data from the CBOE Futures Exchange, where the contract trades. In January, the contract again surged to record levels, trading 138,000 contracts per day. That's nearly 30 times higher than it was for the full year 2009.

Recent gains have occurred despite a relatively placid stock market. The VIX index, which gauges expected swings in stock prices over the next 30 days, spiked no higher than 28 last year. That compares with highs of nearly 50 in the previous two years, and 60 and 80 in 2009 and 2008, respectively.

So, with the VIX muted, why the strong demand for exposure to volatility? According to derivatives professionals, the onward, upward trend in the volatility instruments is not unusual. Despite a calmer stock market, traders have embraced volatility as an integral part of their strategies.

"The concept of volatility as an asset class has taken hold," said Jim Strugger, a derivatives strategist with MKM Partners in Stamford, Conn. "And that will support volumes."

VIX options are traded exclusively at the CBOE, where their value is roughly determined by the value of a same-month VIX futures contract, not the "spot" price of the index itself. VIX futures are traded exclusively on the CBOE Futures Exchange.

Source: CBOE Holdings

Despite the fact that the number of VIX options contracts traded was roughly four times that of VIX futures last year, the notional value of VIX futures is much higher. At an average of $2.5 billion per day last year, the value of trades was approximately double that of VIX options.

The VIX measures the market's expectation of stock market swings by tracking the performance of options on the Standard & Poor's 500 Index. The financial crisis of 2008 propelled the index to a high of 79.13 on Oct. 20 of that year, when, as recently as August, it had been trading under 21.

The surge led Barclays Bank to launch the VXX iPath S&P 500 VIX Short Term Futures exchange-traded note on Jan. 30, 2009, a pioneering security that gave users a direct way to gain exposure to volatility. Other financial institutions soon brought out similar products.