The Relationship of the VIX Index and the Monthly Gross Premiums Generated by the BXM Index; Introducing the “Rule of 10”

Some investors who are new to options have asked these questions:

  • How can I determine how much premium will be generated by a covered call strategy?
  • Is a high VIX level related to high option premiums?
  • If VIX is at a high level, does that mean that a covered call strategy will perform well?

Many factors can influence the premiums generated by different covered call strategies, and a high VIX level does not guarantee that covered calls will have great performance. (For more general options education, please visit

The CBOE S&P 500 BuyWrite Index (BXM) sells one-month S&P 500 index options at mid-day on the third Friday of every month, while the CBOE Volatility Index® (VIX® ) is designed reflect market expectations of 30-day volatility conveyed by S&P 500 stock index option prices.

One could use a “Rule of 10” to try gain the following approximation — if you take the VIX and divide by 10, the resulting number should give you an approximate estimate of the BXM gross monthly premium as a percentage of the S&P 500 Index.  Please see the two charts below for more details.

The two charts above used the term “Gross Premiums” because the numbers shown are not net returns.  Please see the table below to see some relationships between VIX levels and the annual percentage change in value of the BXM and S&P 500 indexes.  Note that in 2008, for example, (1) the VIX had its highest average daily closing values, (2) even though the BXM generated relatively high gross premiums that year, the BXM was down 28.8% that year.  The premiums generated by the BXM Index helped the BXM avert the 37% loss endured by the S&P 500 Index in 2008.


This week the investment advisory firm Asset Consulting Group published a new six –page paper “An Analysis of Index Option Writing for Liquid Enhanced Risk-Adjusted Returns” (available at

Exhibit 12 of the paper notes that the BXM call premiums sold averaged about 1.8% per month since June 1988.

Exhibit 13 of the paper notes that “the average value for implied volatility (as represented by VIX) was 20.27 and the average value for realized volatility was 16.38. A number of studies have shown that the implied volatility inherent in index options prices generally has exceeded subsequent realized volatility over multi-year periods (see Richly priced index options could provide advantages to the option seller.”

Visit for (1) links to several papers that discuss implied and realized volatility, and (2) more information about risk disclosures (e.g., past performance is not a guarantee of future returns).

Video: CBOE Volatility Index – Fact & Fiction Part 1

Watch Part 1 of CBOE’s Fact & Fiction five part educational series, where Dominic Salvino of Group One Trading explains what the VIX measures and why it is often referred to as the “fear gauge”.

The Other Side of VIX

The last three months saw the VIX spot dropped quickly from 30-ish to 10-ish. No wonder XIV, the inverse ETN to the S&P 500 VIX Short-Term Futures Index, was among the top performing ETPs in January. Its return was 30.88% in January 2012 and 14.02% in December 2011.

S&P Indices General Disclaimer

XIV collects daily roll yield when: 1) the VIX futures curve is in contago, and 2) the VIX spot remains flat or down.

The backwardation we saw in Q3 of 2011 was reversed by the end of last November. Contango is back.

S&P Indices General Disclaimer

For investors who expect the equity market to move sideways or up in the near term,  XIV is an interesting investment opportunity. The potential risk is, when catastrophe hit the market, long XIV investors have to pay. In this sense, buying XIV is similar to selling insurance policies.

Click here for more details on contango and roll of the S&P 500 VIX Futures Indices.

VEQTOR & Other Volatility Reduction Indices

Today I’m going to discuss three prepacked investment solutions that seek positive exposure to the equity market with different volatility reduction approaches:

S&P 500 Low Volatility Index: uses stock selection and alternative weighting to minimize portfolio volatility without the use of derivatives or active hedge. PowerShares has issued an ETF (ticker SPLV) that tracks this index.

S&P 500 Dynamic VEQTOR Index: uses a market timing mechanism that dynamically allocates between the 500 and the one-month VIX futures. It continuously monitors the implied volatility and realized volatility of the 500 index to adjust its allocation. Barclay’s has issued an ETN+ (ticker VQT) that tracks this index.

CBOE VIX Tail Hedge Index: uses one-month 30-delta VIX calls to hedge its equity exposure. First Trust will issue an ETF to track this index.

Strictly speaking, the Low Volatility Index has no hedge by design. Its low volatility is achieved by overweighting defensive stocks. When the market falls, the index falls less, but still falls.

The VIX Tail Hedge index uses VIX options as a hedge to its equity exposure. This is a more expensive hedge than using VIX futures. Also, this index does not have any dynamic allocation mechanism that is driven by market signals.

The VEQTOR index uses the most aggressive risk reduction approach among the three. When the market is down, it allocates up to 40% to volatility and expects the gain from the volatility component will more than compensate the loss from the equity component. When the market is up, it reduces its allocation in volatility to as little as 2.5% in order to reduce the hedging cost. It also has a stop-loss function that goes full cash if the index is down by more than 2% over any five-day period.

The performance history shows that VEQTOR outperforms the other two indices in general and tails in returns during a continuously rising market. It has the lowest volatility among the three.

CBOE / Bloomberg: Equity Index Option and Volatility Trading Symposium – Wednesday, Feb. 1

CBOE & Bloomberg present the 3rd Annual Equity Index Option and Volatility Symposium on quantitative strategies, market trends and the outlook for volatility in 2012.

When: Wednesday, February 1, 2012, 3:00-7:00pm
Where: Bloomberg. 731 Lexington Avenue, New York, NY 10022

To register email, with “2.1 CBOE” in the subject line or see “BU ” on the Bloomberg terminal

3rd Annual CBOE/Bloomberg Equity Index Option and Volatility Symposium on quantitative strategies, market trends and the outlook for volatility in 2012.

Ask The Institute: 01/27/12

Watch this video to gain insight on how VIX expiration dates are determined and why they vary from month to month.  Hosted by Michelle Kaufman.

VIX Futures and the Hedging of Bond Portfolios

Equity volatility, as replicated by widely traded ETFs and ETNs linked to the S&P 500® VIX® Futures Index Series, is frequently used to hedge equity portfolios. But is it appropriate for bond portfolios?

The bond market is broad and diverse, ranging from low-risk government bonds to relatively high-risk high-yield corporate bonds and emerging market bonds. As a result, equity volatility relates to each segment of the bond market in the following different ways:

  • Treasury and municipal bonds are positively correlated with equity volatility because they often serve as safe-haven choices when equity risk is at heightened levels. Therefore, adding S&P 500 VIX Futures Index Series exposure to a portfolio of treasury and municipal bonds does not provide diversification benefits.
  • Investment-grade corporate bonds have a weakly positive correlation with equity volatility futures, while high-yield corporate bonds have a weakly negative correlation. During extreme downturns, equity volatility futures can offer corporate bond portfolios some tail risk hedging benefits, but there are occasions when these benefits may not be realized. Risk-return benefits can also be obtained by adding a dynamic allocation of the S&P 500 VIX Futures Index Series to a corporate bond portfolio.
  • The most beneficial application of the S&P 500 VIX Futures Index Series is in emerging market bond portfolios. Adding the S&P 500 VIX Futures Index Series generally provides a clear tail risk hedging benefit. Over the period of study, equity volatility futures provided downside protection on all but four of the worst 25 days for emerging market bonds. An ongoing dynamic allocation to the S&P 500 VIX Futures Index Series has also produced better risk-adjusted returns, with statistically significant outperformance.

Click here to read more.

Exchange Traded Volatility Products in Europe

In Europe, ETFs and ETNs linked to the S&P 500 VIX Futures Indices and the VSTOXX Futures Indices collectively have nearly $380 million in assets ), as listed in Exhibit 1 (note: volume is the average daily volume in December 2011).

Exhibit 1: Exchange Traded Volatility Products in Europe (Dec. 2011)

Compared with the S&P 500 VIX Futures Indices, the VSTOXX Futures Indices show similar diversification properties (details) and sensitivity to VSTOXX spot movements. Since inception, VSTOXX Short Term Futures index has a beta of 48% and the VSTOXX Mid Term Futures index has a beta of 24%. For your reference, the S&P 500 VIX Short Term Futures index has a beta of 47% with the VIX spot, and the S&P 500 VIX Mid Term Futures index has a beta of 23%.

For investors who use the S&P 500 VIX Futures Index Series as a diversification tool in a broad equity portfolio, the term structure decay (especially in the S&P 500 VIX Short-Term Futures Index) is the inevitable cost of a passive hedging strategy (details).  This cost has spurred the development of a second generation of “smart” indices and related ETFs and ETNs, which use algorithmic strategies to either roll or package dynamic allocations in volatility.

In Europe, ETFs linked to two indices seek to give investor positive exposure to volatility at reduced holding cost:

  • S&P 500 VIX Futures Enhanced Roll Index.  Switches between the S&P 500 VIX Futures Short Term Futures Index and a mid-term VIX futures portfolio that holds a rolling position in the third, fourth and fifth month VIX futures contracts. Lyxor issued an ETF (LYMJ GS) on this index.
  • Nomura Voltage Mid-Term Index.  Allocates between the S&P 500 VIX Futures Mid Term Futures Index and 3-month US Treasury. Nomura issued an ETF (VOLT LN) on this index.

Both indices aim to capture spikes in volatility while mitigating the cost of holding a systematically long volatility position. Exhibit 2 and Exhibit 3 show the historical performance of the two indices between May 2011 and December 2011.

Exhibit 2: Performance Statistics of Cost Effective S&P 500 VIX Futures Indices (May 2011 – Dec. 2011)

 Exhibit 3: Cost Effective S&P 500 VIX Futures Indices (May 2011 – Dec. 2011)

Why Are There Different Prices for VIX® Spot and VIX Futures?

Investors often inquire as to why the prices and the price movements for the VIX (spot) Index and the VIX tradable instruments (futures, options, and ETPs) often are different.

For example, yesterday (Tuesday, January 17th) the VIX spot closed at 22.20 and the VIX March futures closed at 25.55 (delayed price quotes are available at

Valuations of VIX futures and options are based on expected values of VIX at the expiration date in the future (rather than the current, or “spot” VIX value). The forward values of the VIX are estimated using the price quotations of S&P 500 options that will be used to calculate the exercise settlement value for VIX on the expiration date (and not the options currently used to calculate spot VIX).

So for example, the current price of the March VIX futures reflects investors’ expectations of what the expected 30-day volatility will be on the VIX futures expiration date of Wednesday, March 20, 2012.

The VIX Index tends to be mean-reverting over long time periods, and the average daily closing value of VIX in the 22 years from 1990 through 2011 was 20.57. The VIX futures prices often are higher than the VIX Index at times when the VIX is at relatively low levels (e.g., under 15). Conversely, the VIX futures prices often are lower than the VIX Index at times when the VIX is at relatively high levels (e.g., above 35).

The historic volatility of daily returns in 2011 was 139.9% for VIX spot and 97.0% for VIX near-term futures.  The VIX spot index usually has bigger moves than the VIX futures.

On August 8, 2011 — the VIX Index (spot) rose 50%, the VIX Aug. 2011 futures rose 25%, and the VIX Nov. 2011 futures were up 10%.

Throughout the months of February through May 2011, the VIX often was in was in contango, except around the time after the March 11 earthquake and tsunami in Japan.

On November 20, 2008 — the VIX Index (spot) reached its highest daily close of 80.86, but the VIX Feb. 2009 futures were priced at 54.67 (reflecting investors’ expectations of the value of VIX three months in the future). In October and November of 2008, the VIX Index often was in backwardation.

Average daily volume in VIX futures grew from 4,543 in 2009 to 47,744 in 2011.

More information on the VIX Index and VIX futures and options is at

VXEEM Futures – 1,106 Trading Volume on the 3rd Day of Trading

Trading volume for security futures on the CBOE Emerging Markets ETF Volatility Index (VXEEM; futures ticker VXEM) was 1,106 contracts on January 11th, (the third day of trading).   In contrast, the trading volume for VIX® futures was 191 contracts on March 30, 2004, its 3rd day of trading.  In addition, options on the VXEEM Index might be launched in future weeks, subject to regulatory approval.


While Wednesday’s settlement value for the VXEEM Index (spot) was 29.82, the settlement value for the March 2012 futures was 34.10.


Reasons for interest in the VXEEM Index include —

  • High Closing Value. The high daily closing value for the VXEEM Index in 2011 was 64.10 on October 3rd, and the low daily closing value was 20.59 on April 20th (in comparison, the high and low daily closing values for the CBOE Volatility Index® (VIX®) in 2011 were 48.00 and 14.62, respectively).
  • Large Upside Moves. The VXEEM Index had single-day upside moves of more than 30 percent on three days in 2011 — August 4th (up 34.2%), August 8th (up 35.5%), and Nov. 25th (up 30.4%).


  • The daily moves for the VXEEM Index had a correlation of negative 0.81 versus both the EEM ETF and the S&P 500 (SPX) Index. This fact demonstrates that investors could explore the possibility of using the VXEEM as a diversification tool.


The VXEEM Index rose to higher levels than the VIX Index in late 2011.

For more information on VXEEM, please visit


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