Jim Lubin is a consultant with the CBOE Futures Exchange (CFE) focusing on the CTA community and VIX futures. He spoke with JLN Options editor Sarah Rudolph about how managers are using the VIX products in their portfolios, different ways of diversifying, and how the CTA business has changed since the crisis of 2008.
Q: What led you to focus on VIX futures?
A: During most of my career I have had some involvement with the CTA community. My objective in joining the CBOE and principally the CFE has been to leverage my experience and knowledge within the managed futures industry in promoting VIX futures and other CFE products.
Before I came to the CFE, I had spent most of my career on Wall Street. My initial position was with Merrill Lynch in New York, where I spent the majority of my time either in the managed futures division or the foreign exchange division. I had a very close relationship with CTAs and managed futures participants during that time. After Merrill Lynch, I had a similar role at Lehman Brothers. More recently I spent the past eight years as a principal with a CTA based in New Jersey that has been in managed futures in the CTA space for close to 20 years. At that organization, I functioned as its COO, and I was involved in many aspects of the firm. One area in which we were very active was developing a volatility-based strategy. That experience opened up new areas for me to develop trading strategies in the volatility space. And it presented me with new information and a new asset class – volatility trading – as a way for managers to profit and to generate alpha with less-traditional instruments than they had typically traded in their portfolios.
Q: How is the recent string of volume records in VIX futures making the product appealing to CTAs and hedge funds?
A: We know that trading volume begets trading volume. In the professional investment manager universe, volume is a huge criterion for a manager to consider in adding a new instrument to their portfolio.
Liquidity is also an important consideration for professional money managers — liquidity not solely based on volume but also on open interest, the bid ask spread, and how easily one can enter and exit the trading arena. The growth in volume we’ve continued to see at CFE has been instrumental in attracting new participants, as has the continued growth in open interest. Open interest is currently around 200,000 – an important benchmark. That shows us that the depth and breadth of participation continues to grow.
Also, managed futures firms don’t just look at volume and liquidity in isolation; they also compare where a given contract stands relative to other instruments in the portfolio. Now that VIX has continued to set new benchmarks and exceeded 40,000 contracts per day in both February and March, that average daily volume number puts the VIX futures contract in very good company, particularly with the typical CTA trade. That supports the argument that VIX should become an important constituent within a portfolio.
Also, there must be a reason to add a new market apart from just further expansion. There must be a certain level of volatility within a contract to make it a reasonable addition to the program. And the VIX futures contract trades at an established inherent level of volatility itself.
Q: Why is diversification a hot topic among trading managers today?
A: A typical CTA in the managed futures space makes the argument that the strategy itself has diversification benefits over a traditional equity or fixed income portfolio. I’m sure you’ve seen all the studies of the non correlation of managed futures to the S&P and fixed income instruments, as well as what the managed futures space offered investors in the Fall of 2008, when a number of asset classes, in particular global equities, underperformed. Today it’s clear that if you’re an equity investor, you’re not getting true diversification simply by allocating to a portfolio of international equities. True diversification is achieved by allocating across a portfolio of non-correlated asset classes. The argument for managed futures is still very much alive and justified.
Managers also look at diversification within individual programs. They are all trying to offer a variety of programs that must be diversified from one another. Trading instruments with a low or negative correlation to other instruments in the program would be desirable. That is another aspect of the VIX futures contract that makes it so attractive – it trades at a different correlation level to other futures contracts. And non-correlation equals diversification.
Q: What types of strategies are managers using to trade VIX futures?
A: We continue to educate and be educated as we speak to managers about how they incorporate VIX in their trading strategies. For example, directional trading managers or momentum-based traders look for trends that have a longer duration – they often use a short position in the VIX as a way to capture the time decay feature that is prevalent in the term structure of the VIX contract. (The farther dated contracts tend to trade at a premium to the nearer dated. Over time those contracts tend to deteriorate in value.)
We’re also seeing interest from shorter term traders who look for opportunities that might include the VIX futures, again going back to the VIX’s internal level of volatility. These types of strategies are developed internally by a CTA or hedge fund, representing proprietary methodologies.
Rounding out that philosophy, we’ve seen managers that use a mean-reverting approach to trading; they are somewhat countertrend in their philosophy. VIX does have an argument for following that approach. I’ve seen some very interesting discussions involving managers who are looking to provide new opportunities in relative value or arbitrage approaches – trading VIX against another contract, for example an equity index or a precious metals contract. Managers are doing a lot of interesting analysis to find intermarket opportunities that include VIX in the mix.
Q: Are CTAs and/or hedge funds using any of the CBOE’s newest products on the VIX, such as the security futures trading on the CBOE Gold ETF Volatility Index (GVZ)?
A: I’ve been involved in the futures contract on the gold volatility index. Interest in that contract is just emerging now. I think there’s a strong curiosity about volatility instruments, and for the CTA community in particular, that futures contract is of more interest than the securities because they use futures more often in their portfolios.
Managers are always looking at what’s new in the marketplace and where opportunities can be found. Gold VIX futures, oil VIX futures, new products at the CFE are in development. The exchange is trying to meet that challenge and support the managers with new and exciting contracts.
Q: How has the CTA business changed since the financial crisis of 2008-2009?
A: The crisis of 2008 in which Lehman Brothers collapsed was an interesting time period for CTAs. The industry exhibited one of best years ever, if you look at the benchmarks that track that industry, and individual managers had historic performance numbers. The industry saw some consolidation as assets left the industry – partly because the restrictions placed on liquidating assets in other investments meant that investors who needed to raise cash could only go to their managed futures accounts, which are highly liquid.
But now in 2010 and 2011 we are starting to see those assets come back and the managed futures space enjoying some growth and money coming back in. The interest in commodity markets means CTAs are including a broad array of instruments in their portfolios, including volatility. We are seeing new managers coming in every day.
One area clearly seeing penetration is the US institutional market. The industry has been patient waiting for that group of investors to finally embrace managed futures. A number of large institutions have recently announced allocations to managed futures programs.
So now we’re back to new record levels of assets under management dedicated to managed futures – we saw assets under management exceed $250 billion in 2010.
Q: How did you first become interested in the trading industry?
A: I had an opportunity to join Merrill Lynch in Manhattan straight out of college in the early 1980s. I was in the futures division. At the time I didn’t know much about the futures industry compared to equities and fixed income. It was a great time to be involved with futures, because it was right at the height of the Hunt Brothers crisis and their efforts in the silver market. It’s been an interesting number of years in managed futures and in the futures industry itself. It has really moved from an agricultural market to one of sophisticated financial products driving volume, for both hedging and speculation.
Q: Any goals for the CFE in the near future?
A: I think the goal is to continue to expand the universe of participants, not just managed futures traders and hedge funds but other users. We’re starting to engage in those conversations and educate the public, particularly around the CFE and futures.