An Interview with Jay Caauwe, CBOE Director of Business Development

Jay Caauwe has been at the Chicago Board Options Exchange since 2003, when he joined as Senior Business Analyst. He has also been an independent trader. He talked with Sarah Rudolph, editor of the JLN Options Newsletter, about the recent volume records in the VIX futures traded at the CBOE Futures Exchange, a subsidiary of CBOE.

Q: As CBOE’s director of business development, did you have a role in developing the VIX futures products traded at CBOE Futures Exchange (CFE)?

A: The product was “built” before I came to the exchange, but I was the first person brought on board as staff for the CBOE Futures Exchange. Of course, the VIX index itself had been calculated since 1993. Through CBOE’s efforts, it was turned it into a tradable futures product in 2004. Our next job was to educate people on its importance – why and how they should use it. I was given a great deal of latitude on how to educate people on the nuances of trading the VIX futures product.

I started my career trading S&P futures in the CME pits. Even back then, all of the traders knew of the importance of the VIX index. It was a barometer you had to be cognizant of to measure market sentiment. Traders had to be aware of what bonds were doing, what currencies were doing, and what the VIX was up to. Becoming a tradable product was the next step in the progression of VIX, and it has become an important component of anyone’s trading strategy, both on the retail and institutional sides.

Q: Do you agree with this statement by Michael McCarty in a recent Reuters story on the VIX volume: “With Tuesday marking the last trading of November VIX futures and options, the sharp drop in the market stimulated interest in the front-month VIX November futures contract with many traders likely closing positions preferring to avoid another potential big move at the opening on Wednesday”?

A: I won’t disagree with Michael, but I think there’s more to it. The fact is that more people have familiarity with how to use VIX futures. Yes, there was closing of front-month November futures, but given the magnitude of the market moves on Tuesday and acknowledging the sensitivity of the front-month futures to the index level, there was considerable two-way flow in the November contract – so it was not just limited to expiration rolling of positions.

In a nutshell, the VIX futures that tie to the SPX quarterly – for example, November is tied to December – generally have the greatest level of open interest. So the front months will be more sensitive to what moves in the index.

Also, historically, there is an upward sloping term structure to the VIX futures. For example, if the December contract is at 20 while the June contract is at 27 – highlighting a considerable price difference – this can create an opportunity for spread trading.

There also has been a lot of attention recently on VIX-related products, such as exchange traded notes, that loop back to our VIX futures. More and more people, who early in VIX futures’ history were unfamiliar with how it worked, now have been attracted to the product since excellent liquidity exists. Open interest in the product has eclipsed 150,000. For many proprietary trading firms and CTAs, the one and only threshold they look at is open interest. If a contract reaches a certain open interest they say, “There must be something to this.” This is the case with VIX futures – the product has become like other very liquid futures products where traders can get in and out easily.

Correlation with other markets is important, too. Traders need to figure out their exposure in other products and how volatility futures can mitigate that risk. The events of 2008-2009 really shed light on why allocation of volatility must be considered in a portfolio.

Q: I understand you to be saying that much of the reason for the recent leap in volume in the VIX futures is the uncertainty that came out of the financial crisis that began in 2008?

A: Yes, the crisis shed light on why volatility is important as an asset class. But don’t underestimate the effect of education on VIX and volatility trading in adding to its usage. Again, the creation of other products that tie back to our futures, market makers seeking a product to scalp throughout the day, and other factors, definitely have affected volumes. Even casual investors need to know about this. So, it’s a combination of things.

Q: Your bio says you studied philosophy and criminology in college. How did you go from there to becoming an expert in options and volatility products?

A: There is no direct correlation, but like most people, I looked at various avenues before becoming involved in financial services. In regard to studying philosophy, everyone has a philosophical approach and a personal philosophy. Clearly, everyone looks to incorporate their own guiding principles in the workplace.

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