Thursday, November 6, 2008

AMEX Ready to Pull the Plug on Fixed Return Options?

Stan Freifeld at has crafted the first draft of an obituary for fixed return options, also known as FROs. In The Death of Fixed Return Options? Freifeld concludes that the absence of new expirations months and strikes suggests the AMEX is likely to phase out FROs soon.

While clearly a fan of FROs, Freifeld highlights six issues which have hampered the development of these new types of options:

  1. New nomenclature required (Finish High and Finish Low)
  2. Large bid/ask spreads
  3. Product not aggressively marketed by the AMEX
  4. Limited availability via brokers
  5. Available on only one exchange (AMEX), with low volume
  6. Utilizes volume-weighted average price (VWAP) for settlement, instead of closing price

I think the salient points are captured above, but ultimately FROs are doomed by the lack of availability via brokers and particularly the large bid/ask spreads. These two issues may be a function of marketing, nomenclature, a single exchange approach or other factors, but ultimately if the spreads are too large, then it becomes extremely difficult to implement a strategy which can overcome such large transaction costs over the long term.

“Fixed return options” is the name the AMEX gives to their all-or-nothing options products. The CBOE uses the term “binary options” for similar options they offer on the SPY and VIX. While SPY binary options are generating some interest, at the money spreads are still in the 0.06 – 0.08 range, which is discouraging a more active market.

Further to my VIX Binary Options post of two months ago, VIX binaries continue to suffer from a lack of interest. This is unfortunate, because in many respects VIX binary options are in much easier to understand and potentially to trade successfully than standard VIX options.

Students of volatility derivatives may recall that the Deutsche Börse launched futures on the VDAX known as the VOLAX back in 1998. While that product launch was not successful, it did pave the way for a successful launch of VIX futures six years later.


gaius marius said...

bill -- sorry this is o/t -- how does one go about calculating the historical volatility you've been referring to lately? is it as simple as standard deviation of the index, or SD of the options, or average SD of the index components, or... something else?

Anonymous said...

found your blog and i hope i can really become a good contributor. i trade vix future calendar spreads. i am always looking for an edge in determining fair value for each months contract.

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Banc de Binary

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