December 5, 2017

Cboe Risk Management Conference Asia

Options and Volatility Benchmarks & Indicators

John Hiatt

Using options benchmarks & volatility indicators

3

Footnotes applied here

Using options for benchmarks & volatility indicators

• Cboe Volatility Index® (VIX®)

• Cboe® S&P 500® Implied Correlation Indexes (ICJ, KCJ, JCJ)

• Cboe® SKEW Index (SKEWSM)

Measure of Investor

Sentiment

• Morgan Stanley High Yield+ Index

• CBOE® Applied Academics TYVIX/VIX® - based Asset Rotation

Strategy (Stabilis)

Inputs for Algorithmic

Asset Allocation Strategy

• Cboe Russell 2000 BuyWrite Index (BXR)

• Cboe Russell 2000 PutWrite Index (PUTR)

• Cboe Russell 2000 Conditional BuyWrite Index (BXRC)

• Cboe Russell 2000 30-Delta BuyWrite Index (BXRD)

Option Strategy

Benchmarks

Comparison of CBOE Russell 2000® PutWrite Index (PUTRSM) and CBOE Russell 2000® BuyWrite Index (BXRSM)

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Despite high correlation, CBOE Russell 2000® PutWrite Index (PUTRSM) substantially outperforms CBOE Russell 2000® BuyWrite Index (BXRSM)

Differences in methodology between the PUTR and BXR matter a great deal and explain the performance difference

Data provided January 31, 2001 through November 15, 2017Source: Cboe Multi Asset Solutions

Breaking the Law of Put / Call Parity?

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RUT BXR PUTR

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SPX BXM PUT

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Detailed discussions of the methodology applied for both indexes is available in the respective white papers on Cboe’s website:http://www.cboe.com/products/strategy-benchmark-indexes/buywrite-indexes/cboe-russell-2000-buywrite-index-bxrhttp://www.cboe.com/products/strategy-benchmark-indexes/putwrite-indexes/cboe-russell-2000-putwrite-index-putr

BXR & PUTR Index Methodologies Compared

BXR PUTR

Exposure• Long Russell 2000 Index (RUT)

• Short 1M RUT at-the-money call option

• 1M Treasury Bill (Cash)

• Short 1M RUT at-the-money put option

Dividends • Re-invested in BXR “units” on dividend “ex-dates”• No dividends to re-invest; expected dividend

priced into put option

Option Roll

• 3rd Friday every month

• Expiring option settles to cash based on Special Opening Quotation (“SOQ”) of RUT

• New option strike based on RUT level at 11 a.m. ET

• New call struck just above RUT 11 a.m. ET level

• 3rd Friday every month

• Expiring option settles to cash based on Special Opening Quotation (“SOQ”) of RUT

• New option strike based on RUT level at 11 a.m. ET

• New put struck just below RUT 11 a.m. ET level

Option Sale

• Deemed sold based on 30-minute VWAP from 11:30 a.m. – 12:00 noon

• Deemed sold based on 30-minute VWAP from 11:30 a.m. – 12:00 noon

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Strike prices for RUT call and put options are not the same

• Call strike for BXR just above RUT level at 11 a.m. ET; call is slightly out of the money

• Put strike for PUTR just below RUT level at 11 a.m. ET; put is slightly out of the money

• PUTR put implied volatility is consistently higher than BXR call implied volatility

Option Roll Mechanics & Expiration Day Effects

• Historically, SOQ for index options has exhibited an upward bias

• Dealers, market makers tend to be sellers of index puts and buyers of index calls, making them long the market

• Unwinding hedges at expiration tends to create buy imbalances in stocks

Footnotes applied here

Exploring BXR & PUTR Methodology Differences

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Analysis based on data from May 2006 through August 2017Source: Cboe Multi Asset Solutions

Expiration Day Effects

BXR PUTR

Expiration Day Return Calculation

• RBXR, EXP = RA x RB x RC ;where

• RA = Return from previous close to SOQ

• RB = Return from SOQ to VWAP option sale – long stock position uncovered

• RC = Return from VWAP option sale to expiration day close

• RPUTR, EXP = RA x “RGAP” x RB ;where

• RA = Return from previous close to SOQ

• “RGAP”= Period from SOQ to VWAP option sale –cash position uncovered

• RB = Return from VWAP option sale to expiration day close

BXR PUTR

RA (Option On) 0.081% 0.058%

RB or RGAP (Option Off) -0.282% 0.000

RC (Option On) 0.089% 0.039%

Expiration Day Return - R -0.117% 0.097%

CBOE® Applied Academics TYVIX/VIX® -based Asset Rotation Strategy (Stabilis)

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CBOE/CBOT 10-Year US Treasury Note Volatility Index (TYVIX)

• TYVIX is the conceptual analogue of VIX for the US Treasury market: a transparent benchmark measuring the fair market value of constant 30-day forward volatility of the benchmark 10-year US Treasury Note futures prices implied by options on 10-year US Treasury Note futures

Morgan Stanley High Yield+ Index (ticker: “MSUSHP5T Index”)

• A long-only, rules-based strategy which aims to generate a return by applying dynamic allocation between the iShares iBoxx H/Y Corporate Bond Fund (ticker: HYG), iShares Barclays 20+ Year Treasury Bond Fund (ticker: TLT) and a Cash Rate.1

CBOE® Applied Academics TYVIX/VIX® - based Asset Rotation Strategy (Stabilis)

• Stabilis is a conceptual analogue to the Morgan Stanley High Yield+ Index that applies a dynamic allocation between SPDR® S&P 500® ETF (ticker: SPY), iShares Core U.S. Aggregate Bond ETF (ticker: AGG), iShares 7-10 Year Treasury Bond ETF (ticker: IEF) and cash based on the levels of VIX and TYVIX.

• It is beneficial to use implied volatility indices for timing asset allocation because the relative movement of equity and bond implied volatilities has historically predicted the relative performance among major asset classes.

1MORGAN STANLEY HIGH YIELD+ INDEX SUPPLEMENT (To Prospectus dated November 19, 2014)); Registration Statement No. 333-200365http://www.morganstanley.com/structuredinvestments/docs/marketingmaterials/High%20Yield+%20Index%20Supplement%20(April%202015).pdf

Origin of Stabilis

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A simple high/low volatility regime model effectively captures VIX spikes.

Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC.

Volatility Regimes: Separating markets by volatility regimes

The regimes are defined based on upward- and downward-crossings of rolling upper and lower quantiles of VIX and TYVIX.

More details can be found at:http://us.spindices.com/documents/research/research-market-timing-with-implied-volatility-indices.pdf

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The simple volatility regimes effectively separate returns in an economically intuitive way. In the LL (“normal”) regime, equities perform best, followed by corporates then Treasuries, and the order is reversed in the HH regime. In the HL regime, equities perform well while fixed income does not, and Treasuries do better than corporates in the LH regime.

Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. Data from March 2004 to September 2017.

Combined VIX and TYVIX Regimes: Return separation FOR EACH REGIME

-9.29%

16.72%15.81% 15.32%

7.32%

-2.16%

4.16% 3.42%

15.47%

-6.19%

6.13%

1.42%1.35% 0.77% 1.37% 1.16%

TYVIX HIGH/VIX HIGH (979 DAYS)

TYVIX HIGH/VIX LOW(373 DAYS)

TYVIX LOW/VIX HIGH (578 DAYS)

TYVIX LOW/VIX LOW(1425 DAYS)

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09

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RETURN DECOMPOSITION BY REGIMES&P500 US Aggregate Bond US Treasury 7-10Year US Treasury Bill 0-3Month

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EMPIRICAL BUILDING BLOCKS Historically …

risk assets perform well during broad market calm, and portfolio aims to be approximately equally risk weighted

bonds significantly underperform equities when there’s isolated anxiety in bond markets

the most severe risk asset drawdowns happen during broad market panics

equities underperform and there’s a flight-to-quality into Treasuries in a broad market panic

Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC.

Stabilis STRATEGYAllocations by regimes

Regime 1: Broad Market Calm

Regime 2: Isolated Anxiety in Bond Markets

Regime 3: Isolated Anxiety in Equity Markets

Regime 4: Broad Market Panic

EQ

20%

CORP

70%

TSY

10%

TYVIX

VIX

CASH

70%

EQ

20%

TYVIX

VIX

TSY

10%

EQ

10%

TYVIX

VIX

CORP

70%

TSY

20%

EQ

10%

CORP

20%

TSY

70%

TYVIX

VIX

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Stabilis US has significantly higher risk adjusted returns compared to a steady 60% equity / 40% bond allocation

Source: S&P Dow Jones Indices LLC, CBOE, Applied Academics LLC. Data from April 1, 2004 to August 31, 2017.

Stabilis STRATEGY Historical Cumulative Performance

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Stabilis US 60% Equity / 40% Bond

Stabilis US 60/40 Fund

Annualized Return (%) 5.75% 6.91%

Volatility (%) 4.28% 10.99%

Sharpe Ratio 1.34 0.63

Max Drawdown 11.2% 36.3%

VIX ETP Market Review

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Top 5 ETPs account for approximately 75% of assets and the top 10 ETPs account for over 95%

There are four strategies that are the most popular: long constant 30-day VIX future (VXX*), 2X long 30-day VIX future (TVIX, UVXY*), short 30-day VIX future (XIV, SVXY*) and conditional 30-day VIX future (PHDG,VQT)

Two structures of VIX ETPs have different effects on VIX futures market (ETF vs. ETN)

Distribution of ETP assets is highly volatile and depends on market factors such as level of VIX and shape of VIX term structure

Over $5 Billion in ETP assets influence VIX futures market…

$1,508.995

$1,086.65

$853.229

$540.30

$420.09

$1,137.30

$238.85

VXX UVXY XIV TVIX SVXY NEXT 5 Rest

Distribution of Volatility ETP assets on 21-Apr-16

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Footnotes applied here

Volatility ETPs Impact on VIX Futures Open Interest

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MIL

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Top 5 Next 5 Rest VIX OI

History of Volatility ETP Assets

VXX, IPATH S&P 500 VIX S/T ETNlaunched January 29, 2009

TVIX, VELOCITYSHARES 2X VIX S/TXIV, VELOCITYSHARES INV VIX S/Tlaunched November 30, 2010

SVXY, PROSHARES INV VIX S/T ETFUVXY, PROSHARES 2X VIX S/T ETFlaunched October 4, 2011

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VXX Exposure Example

Futures Exposure

Future Open Interest Vega

Mar-14 UXH4 177,340 177,340,000

Apr-14 UXJ4 60,755 60,755,000

FutureFutures

Price Futures WeightConstant

Maturity Future VXX PriceVega per ETN

share

Mar-14 UXH4 15.15X

0.8514.995 43.01 2.868

Apr-14 UXJ4 15.45 0.15

ETN Exposure

FutureVega per ETN

shareFutures Weight

Vega per ETN share

ETN Shares Oustanding Vega

Mar-14 UXH42.868 X

0.85 2.438X 21,035,990

51,286,712

Apr-14 UXJ4 0.15 0.430 9,050,596

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Footnotes applied here

Example of ETP effect on VIX Futures Volume

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Cboe Estimate of Proshares VIX Futures Volume

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Top 5 ETPs now account for approximately 85% of assets and the top 10 ETPs still account for over 95%

Overall, ETP assets down approximately 16%, from about $5.7 to $4.9 Billion

Biggest change since April 2016 is the prominence of short volatility ETPs, which now account for over $2.2 Billion in assets

Leveraged VIX ETP assets halved from $1.6 Billion to just under $800 Million

Around $4.9 Billion in ETP assets on November 30…

$1,179.505

$500.56

$1,208.577 $291.45

$992.22

$557.86

$186.34

VXX UVXY XIV TVIX SVXY NEXT 5 Rest

Distribution of Volatility ETP assets on 30-Nov-17

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Short Volatility Trade in 2017

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AUM and Price Return in XIV and SVXY

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Daily Contango in VIX futures

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Cboe®, Cboe Volatility Index® and VIX® are registered trademarks of Cboe. BuyWriteSM, Cboe/CBOT 10-year U.S. Treasury Note Volatility IndexSM,TYVIXSM, CBOE Russell 2000 BuyWrite Index (BXRSM) and CBOE Russell 2000 PutWrite Index (PUTRSM) are servicemarks of Cboe.

Standard & Poor's®, S&P®, S&P 500®, and Standard & Poor's 500® are trademarks of Standard & Poor's Financial Services, LLC and have been licensed for use by Cboe Exchange, Inc. (Cboe). S&P makes no representations or recommendations concerning the advisability of investing in products that have S&P indexes as their underlying interests.

Russell® and Russell 2000® are registered trademarks of the Frank Russell Company, used under license.

Options involve risk and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, by calling 1-888-OPTIONS or from the Options Clearing Corporation at www.theocc.com.

The information in this presentation is provided solely for general education and information purposes. No statement within thispresentation should be construed as a recommendation to buy or sell a security or to provide investment advice.

The CBOE Russell 2000 BuyWrite Index (BXR) and CBOE Russell 2000 PutWrite Index (PUTR) (the “Indexes”) are designed to represent proposed hypothetical buy-write and put-write strategies. Like many passive benchmarks, the Indexes do not take into account significant factors such as transaction costs and taxes. Transaction costs and taxes for the strategies could be significantly higher than transaction costs for a passive strategy of buying-and-holding stocks. Investors attempting to replicate the Indexes should discuss with their brokers possible timing and liquidity issues. Past performance does not guarantee future results.

These materials contain comparisons, assertions, and conclusions regarding the performance of indexes based on backtesting, i.e., calculations of how the indexes might have performed in the past if they had existed. Backtested performance information is purely hypothetical and is provided in this document solely for informational purposes. Backtested performance does not represent actual performance and should not be interpreted as an indication of actual performance. Parameters relating to past performance of strategies discussed are not capable of being duplicated. No representation is being made that any investment will or is likely to achieve a performance record similar to that shown. The methodology of the Indexes is owned by Chicago Board Options Exchange, Incorporated (CBOE). This presentation should not be construed as an endorsement or an indication by CBOE of the value of any non-CBOE product or service described in this presentation.

Copyright © 2017 Cboe Global Markets All rights reserved.

Disclaimer

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