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Futures and Options Update

10/27/2006 12:00 am EST


Lawrence McMillan

Founder and President, McMillan Analysis Corporation

Many investors when looking to augment their long and short portfolio positions, often turn to options investing. And that’s where options expert Larry McMillan comes in handy. Here, he updates his subscribers on volatility and variance futures and options…

“VIX continues to remain low. Therefore, holders of calendar spreads in both Volatility and Variance futures contracts—as well as $VIX options—have done well. That’s because the longer-term futures and options retain a healthy premium over a low $VIX, but the near-term futures have to come down in price to eventually “meet” $VIX, as those futures and options near their expiration dates. On 8/26/06, all the lines were concentrated together in the 150 - 160 area; in futures term (that’s equivalent to $VIX between 15 and 16). Since then, the lines have spread apart. The width of that spread represents the profit to someone who had been holding a calendar spread (i.e., long Feb or May ‘07 futures and simultaneously short contracts expiring in ‘06).

“At the present time, that same strategy using those identical contracts would not be optimal. Rather, if you currently feel $VIX is going to remain at fairly low levels, you would likely buy May ’07 VIX futures and sell Feb ‘07.

“A similar thing has taken place in variance futures, but here you would have to have been short the Dec ’06 contract against any ‘07 contract in order to hold a profitable calendar. Currently, all the ‘07 Variance contracts are trading at very similar prices, so shorting March ‘07 and buying June ‘07 would be the calendar you’d want to use if you feel VIX will remain low. However, if you think $VIX will increase, these “standard” calendars will likely not work and in fact might even invert. This is the possibility we discussed in the last issue, when we recommended a reverse put calendar in VIX options as a way to play for an increase in $VIX. Such an increase has not been forthcoming, so the put spread is marking down.

“However, we still think that spread is a viable approach if VIX does, indeed, increase. In addition, we think that it can still be established by buying VIX Feb 20 puts (VIXND) and selling VIX Nov 20 puts (VIXWD), despite the impending approach of November expiration (11/15/06). The put spread is heavily dependent on what VIX does between now and November expiration.

“If you want something that is a little less sensitive to VIX near-term movements, you could sell VIX Dec 20 puts instead of the Nov 20's. In either case, the spread will do best if VIX rallies towards 20, and will do worse if $VIX falls in price.”