EQUITY RESEARCH

Equity Linked Strategies | U.S. Derivatives Strategy | July 27, 2011

THE VIX COMPASS
A Guide to the VIX Derivatives Landscape
In this weekly publication, we provide a comprehensive overview of the VIX derivatives landscape. The aim is to provide value-added market intelligence covering VIX ETNs, VIX futures and options. This publication also serves as a forum to monitor the performance of several of the hedging and alpha strategies we have previously analyzed.
Maneesh Deshpande +1 212 526 2953 maneesh.deshpande@barcap.com BCI, New York Rohit Bhatia +1 212 526 0367 rohit.bhatia@barcap.com BCI, New York Ashish Goyal +1 212 526 2771 ashish.goyal@barcap.com BCI, New York

Market Commentary
Over the past week VIX August futures were almost unchanged while the rest of the curve experienced a small downward shift. The S&P 500 gained 0.4% in this period (Figure 19). The realized volatility of VIX futures and VXX continued to be high last week (Figures 13, 30). VIX August implied volatility increased last week while the longer maturity implied volatilities remained at the same levels (Figure 27). VIX 1M skew steepened last week and is now close to its last one-year high (Figure 25).

Systematic Alpha Strategies
Increase in VIX August implied volatility and high realized volatility of VIX futures led to a decline of 1.2% for the short VIX delta-hedged strategy. Short SPVXSTR long SPVXMTR strategy lost 1% over the past week as VIX longer maturity futures declined while VIX August futures were almost unchanged. The VIX 1x2 Put spread and the VIX Calendar strategies had positive returns of 1.2% and 0.3% respectively over the past week. While the VIX 1x2 put spreads benefited from steepening of the skew, VIX calendars had positive returns due to steepening of the VIX volatility term structure. Short SPVXSTR long VST1MT (European volatility futures index) strategy gave back some of the gains as the VSTOXX futures declined over the past week.

Link to US VolCenter
Vol Center is a premier Equity Derivatives application providing Market Data, Analytics, Market Insight and Research Source for all charts and tables: Barclays Capital, OptionMetrics, Bloomberg

Systematic Hedging Strategies
Among the VIX-based hedging strategies, VIX 3M 1x2 calls spreads and 1M risk reversals outperformed other strategies as they benefited from the steepening of the skew.

Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 27.

Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

CONTENTS

VOLATILITY LIQUIDITY LANDSCAPE VIX ETNS-1 VIX ETNS-2 VSTOXX ETNS VIX FUTURES VIX OPTIONS-1 VIX OPTIONS-2 HEDGING STRATEGIES – VIX ETNS & VIX OPTIONS HEDGING STRATEGIES - COMPARISON ALPHA STRATEGIES ALPHA STRATEGIES COMPARISON MARKET INTELLIGENCE HEDGING STRATEGIES: METHODOLOGY ALPHA STRATEGIES: METHODOLOGY SELECTED VIX-RELATED PUBLICATIONS

3 4 5 6 7 8 9 10 11 12 13 14 18 22 26

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

VOLATILITY LIQUIDITY LANDSCAPE1
Figure 1: Total Vega Outstanding ($ Millions)
600 500 400 1500 300 1000 200 100 0 Jul-10 Sep-10 Nov-10 VIX Futures Jan-11 VIX Options Mar-11 VIX ETN May-11 Listed SPX Options (RHS) Jul-11 500 0 2500 2000

Total Vega Outstanding is the weekly moving average of the daily vega outstanding.

Figure 2: Total Vega Volume ($ Millions)
180 160 140 120 100 80 60 40 20 0 Jul-10 Sep-10 Nov-10 VIX Futures Jan-11 VIX Options VIX ETN Mar-11 May-11 Jul-11

Listed SPX Options

Total Vega Volume is the weekly moving average of the daily vega volumes traded.

1

For more information on the charts please click the figure title

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VIX ETNS-1
Figure 3: Price Performance of VXX & VXZ
120 100 80 60 40 20 0 Jul-10 Nov-10 VXX Mar-11 VXZ

Figure 4: Estimated VXX & VXZ Monthly Roll Cost
20% 15% 10% 5% 0% -5% -10% Jul-10 Nov-10 VXX (LHS) Mar-11 VXZ (RHS) 6% 5% 4% 3% 2% 1% 0% -1% -2% -3%

Prices are normalized to 100 at the starting date to compare the performance.

Roll cost is estimated using the term structure premium in VIX futures.

Figure 5: VXX & VXZ Vega Outstanding
140 120 Vega(MM)

Figure 6: VXX & VXZ Vega Volume
70 60 50 Vega(MM) 40 30 20 10 0

100 80 60 40 20 0 Jul-10 Dec-10 VXX VXZ Apr-11

Jul-10

Dec-10 VXX VXZ

Apr-11

Vega per share on day t is calculated as the ratio of the VIX ETN and the relevant constant maturity VIX future on day (t-1).

Volume: Weekly Moving Average

Figure 7: VXX Short Interest & XXV Vega Outstanding
60 50 Vega(MM) 40 30 20 10 0 Jul-10 Nov-10 VXX SI Vega Mar-11 XXV SO Vega

Figure 8: Notional of VIX ETN to hedge $100 of SPX
50 45 40 35 30 25 20 15 10 Jul-10 Nov-10 VXX Mar-11 VXZ

Short interest data is released every two weeks.

Calculated using rolling 6 month overlapping weekly returns.

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VIX ETNS-2
Figure 9: VXX & VXZ Vega/Share
4.0 3.5

Figure 10: VXX Option Open Interest and Volume
1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Jul-10 Sep- Nov- Jan- Mar- May- Jul-11 10 10 11 11 11 Open Interest (LHS) Volume (RHS) 250 200 150 100 50 0

Contracts('000)

3.0 2.5 2.0 1.5 1.0 0.5 0.0 Jul-10 Nov-10 VXX Mar-11 VXZ

Vega/Share: Price change in ETN for 1 point change in VIX futures.

Volume: Weekly Moving Average

Figure 11: VXX Vol Term Structure and Open Interest
74% 72% 70% 68% 300 66% 64% 62% 60% Aug-11 Oct-11 Dec-11 Feb-12 ATM IV(LHS) 200 100 0 600 500 400 Contracts('000)

Figure 12: VXX Skew Snapshot
95% 90% 85% 80% 75% 70% 65% 60% 55% 50% 20 25 30 35 40 45 50 55 60 2M IV 65 70 75 80 Put Delta

Open Interest(RHS)

1M IV

ATM IV corresponds to 50 delta implied volatility for the relevant maturity.

Volatility across standardized put deltas

Figure 13: VXX 1M & 2M Implied Volatility Time Series
100% 90% 80% 70% 60% 50% 40% 30% 20% Jul-10 Oct-10 Dec-10 Feb-11 2M IV Apr-11 1M RV Jun-11

Figure 14: VXX Skew Time Series
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Jul-10 Sep-10 Dec-10 Feb-11 1M Apr-11 2M Jun-11

1M IV

50 delta Implied volatility for constant maturity 1M and 2M VXX options

Skew = (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)

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Contracts('000)

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

VSTOXX ETNS
Figure 15: Price Performance of VSXX (in €)
35 30 25 20
60

Figure 16: Total VSXX Volume & Shares Outstanding (in €)
120 100 80 16 14 12 10 8 6 4 20 0 2 0 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11

15 10 5 0 Jul-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11
40

Jul-10

VSXX Price (€)

AUM (MM €)

Volume(MM €) (RHS)

Price source: Frankfurt Exchange

Volume: Weekly moving average of sum over exchanges.

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VIX FUTURES
Figure 17: VIX 1M & 4M Constant Maturity
35 33 31 29 27 25 23 21 19 17 15 Jul-10 Nov-10 VIX Future 1M Mar-11 VIX Future 4M

Figure 18: Performance of VIX Futures Rolled at Expiry
120 100 80 60 40 20 0 Jul-10 Nov-10 1M Rolled At Expiry SPVXSP Mar-11 4M Rolled At Expiry SPVXMP

Constant maturity VIX Futures are calculated by interpolation.

Cumulative excess returns are used for showing the performance.

Figure 19: VIX Futures Term & Open Interest Snapshot
70 60 Contracts('000) 50 40 30 20 10 0 Aug-11 OI Today(LHS) Oct-11 Dec-11 Feb-12 Future Wk Ago 25 24 23 22 21 20 19 18 17 16 15

Figure 20: Hedge Ratio of VIX Futures versus SPX
45% 40% 35% 30% 25% 20% 1M 2M 3M 4M 5M 6M

Future Today

Hedge Ratios are calculated using past 2 year overlapping weekly returns.

Figure 21: VIX Futures Slope
117% 112%

Figure 22: Aggregate VIX Futures Volume and Open Interest
90 80 Contract('000) 70 60 50 40 30 20 10 0 Jul-10 Nov-10 Mar-11 300 250 200 150 100 50 0 Contract('000)

107% 102% 97% 92% Jul-10 Nov-10 Mar-11

2M/1M VIX Fut

4M/3M VIX Fut

Volume(LHS)

Open Interest(RHS)

Ratio of constant maturity VIX futures

Volume: Weekly Moving Average

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VIX OPTIONS-1
Figure 23: VIX 1M and 2M ATM Volatility
120% 110% 100% 90% 80% 70% 60% Jul-10 Nov-10 ATM 1M IV Mar-11 ATM 2M IV

Figure 24: VIX 1M and 2M Skew Snapshot
135% 125% 115% 105% 95% 85% 75% 65% 55% 25 30 35 40 45 50 55 Put Delta 2M IV 60 65 70 75

1M IV

Volatility surface fitted to get the ATM IV (50 Delta volatility).

Volatility for standardized put deltas

Figure 25: VIX 1M and 2M Skew
70% 60% 50% 40%

Figure 26: VIX 2M/1M ATM Volatility Ratio

100% 90% 80%

30% 20% 10% Jul-10 Nov-10 1M Skew Mar-11 2M Skew

70% 60% Jul-10 Nov-10 Mar-11

2M/1M VIX Vol

Skew= (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)

Ratio of 50 delta implied volatilities

Figure 27: VIX ATM Volatility and Open Interest Term Structure Snapshot
110% 100% 90% 1500 80% 1000 70% 60% 50% Aug-11 Sep-11 Oct-11 VIX ATM IV Today Nov-11 Dec-11 Expiry 500 0 2500 2000 Contracts('000)

Open Interest Today (RHS)

VIX ATM IV 1 Wk Ago

VIX 50 delta implied volatility for different maturities

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VIX OPTIONS-2
Figure 28: VIX Option Call and Put Open Interest
7,000 6,000 Contracts('000) 5,000 4,000 3,000 2,000 1,000 0 Jul-10 Dec-10 Apr-11 Call Open Interest Put Open Interest

Figure 29: VIX Option Call and Put Volume
900 800 Contracts('000) 700 600 500 400 300 200 100 0 Jul-10 Dec-10 Call Volume Apr-11 Put Volume

Open interest across maturities

Volume: Weekly Moving Average

Figure 30: VIX Vol versus SPX Skew and VIX Fut. Realized Vol
100% 90% 80% 70% 60% 50% 40% 30% 20% Jul-10 VIX 2M IV Nov-10 Mar-11 VIX Future 1M RV 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0%

Figure 31: 2M ATM SPX Volatility versus 2M VIX Skew
30% 25% 20% 15% 10% 5% 0% Jul-10 Nov-10 SPX 2M IV Mar-11 VIX 2M Skew (RHS) 10% 15% 20% 25% 30% 35% 40% 45% 50% 55% 60%

SPX 2M Skew (RHS)

RV of Constant Maturity 1M VIX Future returns over rolling one month.

Skew = (25D Call Vol)/(50D Call Vol) - (25D Put Vol)/(50D Put Vol)

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

HEDGING STRATEGIES – VIX ETNS & VIX OPTIONS
Figure 32: SPX Hedged with SPVXSTR & SPVXMTR
145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11 SPX + SPVXMTR

Figure 33: SPX Hedged with Short SPVXSTR Long SPVXMTR
165 145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 S&P 500 Jun-09 Apr-10 Jan-11

S&P 500

SPX + SPVXSTR

SPX + SPVXMTR- SPVXSTR

Calculated hedge ratio from past 6 month overlapping weekly returns.

Notional amount of VXX is one-third of VXZ notional amount.

Figure 34: SPX + VIX Call Options
145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 S&P 500 Jun-09 Apr-10 Jan-11

Figure 35: SPX + VIX Risk Reversals
145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 S&P 500 Jun-09 Apr-10 Jan-11

SPX + VIX Call Option

SPX - VIX Risk Reversal

S&P 500 portfolio is hedged with 40% dollar notional VIX 3M 20% OTM calls.

VIX 1M 80%- 120% risk reversal of 30% dollar notional is used for hedging.

Figure 36: SPX + Short VIX 1x2 Call Spreads
145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 S&P 500 Jun-09 Apr-10 Jan-11

Figure 37: SPX + Zero Cost 12M Put Spread Collar
145 125 105 85 65 45 Jan-07 Nov-07 Aug-08 S&P 500 Jun-09 Apr-10 Jan-11

SPX - VIX 1x2 Call Spread

SPX + 12M Zero Cost SPX Put Spread Collar

VIX 3M 1x2 120%-150% call spread of 40% notional is used.

Put spread strikes in the strategy are 80% and 95%.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

HEDGING STRATEGIES - COMPARISON

Figure 38: Performance Comparison of Hedging Strategies since 2007

Strategies

Average Return

Standard Deviation

Sharpe Ratio

Sortino Ratio

Drawdown

1 Week Return

3 Month Return

S&P 500 SPX Hedged with long 3M 120% VIX CallOption SPX Hedged with short 1M 80%-120% VIX Risk Reversal SPX Hedged with short 3M 120% 150% 1x2 VIX Call Spread SPX Hedged with long SPVXSTR SPX Hedged with long SPVXMTR SPX Hedged with long SPVXMTR & short SPVXSTR SPX Hedged with 12M Zero Cost 80% 95% SPX Put Spread Collar

4.1% 6.6% 5.8% 6.5% 0.2% 8.5% 10.9% 4.4%

26.4% 20.7% 21.8% 25.9% 14.6% 16.3% 23.0% 17.1%

0.09 0.24 0.19 0.19 -0.10 0.42 0.41 0.16

0.13 0.35 0.28 0.27 -0.14 0.63 0.58 0.23

-55.3% -40.5% -36.8% -51.2% -29.2% -30.2% -47.1% -37.4%

0.4% 0.1% 0.6% 0.5% 0.3% 0.0% 0.0% 0.1%

-1.3% -2.6% -4.5% -2.0% -2.1% -3.0% -2.6% 0.7%

Source: Barclays Capital, OptionMetrics, Bloomberg

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

ALPHA STRATEGIES

Figure 39: Short SPVXSTR & Long SPVXMTR

Figure 40: Short Delta Hedged 1M ATM VIX Straddles
300

250

250
200

200
150

150 100 50
Nov-07 Aug-08 Jun-09 Apr-10 Jan-11

100

50 Jan-07

Jan-07

Nov-07 Aug-08

Jun-09

Apr-10

Jan-11

Long VXZ amount is 100% of equity while short VXX is 50%.

0.15 vega per $100 of equity is sold through delta-hedged straddle.

Figure 41: 1M 80%-100% 1x2 VIX Put Spread
250 230 210 190 170 150 130 110 90 70 50 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11

Figure 42: Long 1M ATM VIX Put & Short 2M Same Strike Put
230 210 190 170 150 130 110 90 70 50 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11

Dollar notional of 1M ATM VIX put is 100% of equity.

Dollar notional for both long and short puts is 100% of the portfolio equity.

Figure 43: Short SPVXSTR & Long VST1MT
200 180 160 140 120 100 80 60 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11

Figure 44: Equal Volatility Combined Strategy
240 220 200 180 160 140 120 100 80 Jan-07 Nov-07 Aug-08 Jun-09 Apr-10 Jan-11

Amount of VXX sold and VSXX bought are same.

Weights for different strategies are calculated using past 3M realized volatility over overlapping weekly returns.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

ALPHA STRATEGIES COMPARISON
Figure 45: Performance Comparison of Alpha Strategies since 2007

Strategies

Average Return

Standard Deviation

Sharpe Ratio

Sortino Ratio

Drawdown

1 Week Return

3 Month Return

S&P 500 SPVXSTR versus SPVXMTR Delta Hedged 1M ATM VIX Straddle VIX 1M 80%-100% 1x2 Put Spread VIX Long 1M ATM Put and Short 2M Same Strike Put Long VST1MT Short SVPXSTR Equal Volatility Combined Strategy

4.1% 20.0% 22.0% 14.9% 14.3% 20.5% 18.8%

26.4% 16.0% 13.5% 23.2% 19.3% 37.5% 11.5%

0.09 1.15 1.52 0.57 0.66 0.50 1.49

0.13 1.63 1.92 0.82 0.93 0.80 2.05

-55.3% -25.3% -15.1% -32.2% -23.9% -26.8% -10.0%

0.4% -1.0% -1.2% 1.2% 0.3% -4.5% -1.4%

-1.3% -3.6% 14.3% -14.7% -20.3% 2.7% -1.1%

Source: Barclays Capital Inc. OptionMetrics, Bloomberg

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

MARKET INTELLIGENCE Volatility Liquidity Landscape
Figure 1: Total Vega Outstanding: We express open interest in vega since that allows us to do a comparison across products. For SPX options we calculate the total vega across all strikes and maturities by multiplying open interest by vega/contract for each option. Vega outstanding of the VIX ETNs is calculated by multiplying the open interest of VIX ETNs (VXX, VXZ and XXV) by their respective vega/share. The vega/share on day t of VXX and VXZ can be shown to be the ratio of the close price of the VIX ETN and the corresponding constant maturity VIX future on day t-1. We emphasize that this is not a constant and changes over time (see Figure 9: VXX & VXZ Vega/Share). The vega/share for XXV is simply the vega/share of VXX times number of VXX shares per one share of XXV at the IPO of XXV. In the case of VIX futures, vega outstanding equals the open interest of VIX futures times 1000 as the multiplier of each VIX future is 1000 and it has one vega/share. Since the delta of VIX options is the sensitivity of the options with respect to VIX futures, vega outstanding of VIX options is simply the sum of the delta times open interest of all listed VIX options. Figure 2: Total Vega Volume: Vega volume of VIX ETNs, VIX futures and VIX options is defined in a similar manner as in Figure 1 with the trading volumes replacing the open interest.

VIX ETNs-1
Figure 3: Price Performance of VXX and VXZ: Price performance of VXX and VXZ is plotted for a trailing one-year period. Prices are normalized to 100 at the start date to directly compare the performance of the two ETNs. Figure 4: Estimated VXX and VXZ Monthly Roll Cost: We estimate the roll cost of the VXX and VXZ using the term structure of constant maturity VIX futures. Assuming that the volatility surface remains constant, roll cost of VXX can be estimated as 0.5*(VIX 2M future – VIX)/(VIX 1M future). Applying the same assumptions, VXZ roll cost is estimated as 0.5*(VIX 6M future – VIX 4M future)/(VIX 5M future). Constant maturity VIX futures are calculated here by linearly interpolating VIX futures for the given constant maturities. Figure 5: VXX and VXZ Vega Outstanding: Vega outstanding of the VIX ETNs is calculated as the open interest of the ETNs times their respective vega per share. Time series of vega per share for VXX and VXZ is shown in Figure 9: VXX & VXZ Vega/Share. Figure 6: VXX and VXZ Vega Volume: Similar to the calculations of vega outstanding of the VIX ETNs, vega volume is simply vega per share times the trading volume of each ETN. The figure shows weekly moving average of the daily vega volume of the ETNs.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

Figure 7: VXX Short Interest and XXV Vega Outstanding: To get an idea of the amount of VXX being shorted, we show VXX short interest vega and XXV outstanding vega in the figure. We calculated the short interest vega of VXX as the vega per share times short interest of VXX. The figure shows two data points for each month as short interest is published only twice a month. Figure 8: Notional of VIX ETN to hedge $100 of SPX: Simple linear regression is used to calculate the hedge ratio of SPX with respect to the ETNs (VXX and VXZ). We use overlapping weekly returns over the trailing six months for the regression.

VIX ETNs-2
Figure 9: VXX and VXZ Vega/Share: The vega/share on day t of VIX ETNs (VXX and VXZ) is the ratio of the close price of the VIX ETN and the corresponding constant maturity VIX future on day t-1. The vega/share reflects the change in the price of VIX ETNs corresponding to 1 point parallel shift in VIX futures across the term structure. Figure 10: VXX Option Open Interest and Volume: To monitor the liquidity of VXX options, open interest and volume of VXX options are shown in the figure. The graph has data from May 2010, which was when VXX options listed. Figure 11: VXX Vol Term Structure and Open Interest: We plot at-the-money (50 Delta) implied volatility of VXX for listed maturities to get the snapshot of VXX volatility term structure. Also shown is the open interest in various listed options contracts on VXX for the same expirations. 50 Delta implied volatility is calculated by taking the average of 50 Delta Call and Put implied volatilities. Figure 12: VXX Skew Snapshot: VIX futures are inversely correlated to SPX and hence VXX, which is a portfolio of long 1M and 2M VIX futures, and is also inversely correlated to SPX. This inverse correlation is reflected in the opposite skew of VXX (OTM calls having a higher implied volatility than OTM puts) with respect to SPX. The figure shows the snapshot of VXX 1M and 2M implied volatility across standardized put deltas. Figure 13: VXX 1M and 2M Implied Volatility Time Series: Time series of at-the-money (ATM) (50 Delta) implied volatility of VXX for standardized maturities 1M and 2M are shown since May 2010, which was when VXX options listed. Figure 14: VXX Skew Time Series: The figure plots the times series of the 1M and 2M VXX skew since May 2010. Skew here is defined as (25D Put Vol)/(50D Put Vol) - (25D Call Vol)/(50D Call Vol).

VSTOXX ETNs
Figure 15: Price Performance of VSXX (in €): ETNs linked to VSTOXX futures started to trade in September 2010 on several European exchanges (Frankfurt, both Euro and GBP denominated listings on London). This figure plots VSXX price performance using closing prices from the Frankfurt exchange, which has the highest liquidity. Figure 16: Total VSXX Volume and Shares Outstanding (in €): Total daily volume and shares outstanding are calculated by summing across all exchanges, converted into euros. Weekly moving average of this daily volume (calculated above) is plotted in this figure.

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VIX Futures
Figure 17: VIX 1M and 4M Constant Maturity: The constant maturity futures are calculated by interpolating the VIX futures term structure using an exponential fit. Constant maturity VIX futures help identify the pure price performance of VIX futures, without taking into account the roll cost. Figure 18: Performance of VIX Futures Rolled at Expiry: In contrast to VIX ETNs, which are rolled daily, we have also plotted the performance of strategies where VIX futures are only rolled each month at the VIX futures expiration date. In Figure 18: Performance of VIX Futures Rolled at Expiry, we show the performance of 1M VIX future held until it expires and of 4M VIX future held for one month until VIX futures expiration date (it is now a 3M VIX future), at which point it is rolled to the next 4M future. As we can see, rolling daily improves performance relative to monthly rolling. Figure 19: VIX Futures Term and Open Interest Snapshot: This figure plots the current VIX futures term structure and the term structure from one week back. The figure gives an idea of the movement in the term structure over the past week. Figure 20: Hedge Ratio of VIX Futures versus SPX: Shorter-dated VIX futures are more sensitive to movements in SPX relative to longer-dated futures. This is reflected in the higher hedge ratio of SPX relative to longer-dated VIX futures, or in other words more longer-dated VIX futures are required to hedge a given SPX position in comparison to shorter-dated futures. Hedge ratio is calculated using simple linear regression of SPX versus VIX futures overlapping weekly returns over the last two years. Figure 21: VIX Futures Slope: The slope of the VIX term structure is usually steep in the short end and flattens toward longer-dated futures. The ratio of the 1M/2M VIX futures gives an indication of the steepness of the nearer end of the curve while the ratio of 4M/3M VIX futures measures the steepness in the longer-dated part of the curve. Figure 22: Aggregate VIX Futures Volume and Open Interest: The curve here shows VIX future volume and open interest across all the maturities for the last 1 year. Volume is the weekly moving average of the daily volumes.

VIX Options – 1
Figure 23: VIX 1M and 2M ATM Volatility: To calculate the VIX volatility surface, we first note that the underlying for each VIX option with different maturity is a different VIX future. We calculate the implied volatility for each option contract with the underlying VIX future having the same maturity as the expiry of the option contract. We only keep options with absolute delta between 5 and 75 to remove points where implied volatility calculation is very sensitive to bid ask spreads. We then use a simple quadratic regression for each option expiry to identify and correct other outliers. A localized kernel regression method is employed over the corrected data to parameterize the implied volatility for given standard deltas and expiries. Localized kernel regression method helps us preserve the shape of the implied volatility surface without placing simplified constraints about the shape of the surface. VIX ATM volatility is defined as the implied volatility of 50 delta option. Figure 24: VIX 1M and 2M Skew Snapshot: Negative correlation between VIX futures and SPX returns implies that the sign of VIX skew is flipped with respect to SPX skew. In the figure we plot implied volatility of standardized VIX options using the volatility surface to show the skew of 1M and 2M VIX options.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass

Figure 25: VIX 1M and 2M Skew: We calculate VIX skew as: (25D Call Vol)/(50D Call Vol) (25D Put Vol)/(50D Put Vol). The formula used to calculate the skew of VIX is opposite in sign to the formula used for calculating SPX skew in Figure 30. Figure 26: VIX 2M/1M ATM Volatility Ratio: Longer-dated VIX futures are less volatile than shorter-dated futures. As the VIX futures approach expiry, their volatility increases leading to a downward sloping term structure of VIX volatility. The figure shows the ratio of 2M ATM VIX Volatility and 1M ATM VIX Volatility. Figure 27: VIX ATM Volatility and Open Interest Term Structure Snapshot: VIX ATM volatility is the implied volatility of 50 delta option for the listed expiries. The figure compares the latest term structure of volatility of VIX with the term structure one week back.

VIX Options – 2
Figure 28: VIX Option Call and Put Open Interest: Open interest in the figure is the aggregate open interest across all the maturities. Historically, call option open interest has been significantly higher due to higher demand for out-of-the-money VIX call options, used for hedging equity portfolios. Figure 29: VIX Option Call and Put Volume: Similar to the open interest shown in Figure 28, the volume shown is the weekly moving average of the aggregate volume of VIX options across all maturities. Figure 30: VIX Vol versus SPX Skew and VIX Fut. Realized Vol: As discussed previously in Index Volatility Weekly – Valuing Vol of Vol– September 28, 2009, VIX ATM volatility very closely tracks SPX skew. An intuitive explanation for this effect comes from using a simple sticky strike model. We can provide (slightly) more rigour by using an explicit stochastic volatility model. Perhaps the simplest stochastic volatility model is the SABR model where we can write:

dSt = σ t St dZ1t ; dσ t = νσ t dZ 2t ; 〈 dZ1t dZ 2t 〉 = ρ
Thus as opposed to the Black-Scholes model the volatility, σ is also assumed to be stochastic and driven by another random process dZ 2 . It can be shown that this model generates a skew in the implied volatilities and can be approximated as:

σ imp ( K ) = σ o − ρυ log ⎜

⎛K⎞ ⎟ ⎝ So ⎠

Thus the skew (defined as the coefficient of the log strike) is directly proportional to the volatility of instantaneous volatility. In this simple model VIX volatility will also be proportional to υ and is thus proportional to the SPX skew. As an aside, note that, if the correlation ρ is -1, then we immediately see that this is equivalent to a sticky strike model. The above model is too simplistic in that it ignores the mean reversion of volatility which leads to a declining term structure of VIX volatility. Figure 31: 2M ATM SPX Volatility versus 2M VIX Skew: VIX skew has strong correlation with SPX ATM volatility.

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HEDGING STRATEGIES: METHODOLOGY
In this section we compare different hedging strategies for an S&P 500 portfolio. The instruments considered are VIX options and VIX-based ETNs. We also show the performance of SPX hedged with a 12M rolling SPX put spread collar, which is one of the best performing conventional equity options-based hedges. All of the considered strategies are rebalanced monthly at VIX futures expiration dates. Performance of the strategies is calculated assuming that the hedges are initiated using a monthly total return swap with money borrowed/lent at the daily Fed funds rate to initiate the hedge. The equity position (S&P 500) of our portfolio is adjusted each month at rebalance dates according to the gain or loss on the hedge. This ensures that the amount borrowed for the hedge does not keep on growing. For example, if on rebalance date we have $100 of SPX and we need $40 of a certain hedge, we will borrow $40 to initiate the hedge. At the next rebalance date the gain/loss of the hedge will be added/subtracted from the equity position (which equals the long SPX position in this case). All positions are marked to market daily and dividends are assumed to be reinvested continuously. We use SPVXSTR and SPVXMTR (VIX short term and medium term future indices) for calculating the performance of the VIX futures based indices. Performance of the strategies is shown from January 2007. A brief description of the strategies and the sizing used is described in the following section.

SPX Hedged with VIX ETNs
We consider three hedging strategies for S&P 500 using VIX ETNs:

SPX Hedged with SPVXMTR (Figure 32)
In our previous publications (please see: Index Volatility Weekly - VXZ as a Tail Risk Hedge – September 27, 2010), we have discussed the advantages of using SPVXMTR as an equity hedge. While it performs well as a hedge during highly volatile environments, it has also carried well during quiet periods, making it a less costly hedge to carry. To calculate the hedge ratio we use the trailing beta of SPX versus SPVXMTR calculated using overlapping weekly returns over the trailing six-month period. We rebalance the portfolio every month using the new hedge ratio. While the hedge ratio can fluctuate between -10% and 120%, we restrict the range to between 20% and 80%. This allows us to have a reasonable hedge ratio even in situations where a few data points can lead to the hedge ratio reaching very low or very high levels. During high volatility periods, beta increases for two reasons: 1) the correlation of SPX returns and SPVXMTR returns increases and 2) the increase in volatility of SPX is more than the increase in volatility of SPVXMTR. The cumulative effect of these two separate effects is to increase the hedge ratio during high volatility periods, which is when there is the most need for the hedge. In terms of risk-adjusted returns, SPVXMTR hedge has performed better than most of the hedges considered since 2007. It has higher returns and lower standard deviation relative to a pure equity portfolio.

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SPX Hedged with SPVXSTR (Figure 32)
SPVXSTR tracks the shorter-dated VIX futures in contrast to SPVXMTR which tracks longerdated futures. Historically SPVXSTR has had a higher cost to carry during quiet periods, which makes it a more expensive hedge. In return, it has a higher convexity during volatile periods. Similar to SPVXMTR, we use a trailing six-month rolling beta calculated over weekly returns to determine the hedge ratio. We use bounds of 10% and 40% on the hedge ratio. In terms of performance, while SPVXSTR does reduce draw-down during market declines, it also loses value much faster during more normal times. Consequently, it has worse risk-adjusted ratios than a SPVXMTR hedge.

SPX Hedged with Long SPVXMTR + Short SPVXSTR (Figure 33)
Since VXX has a much higher carry cost, a popular alpha strategy is to go long SPVXMTR and go short SPVXSTR. This can also be used as a hedge for SPX by maintaining a high SPVXMTR:SPVXSTR ratio such that it retains a long volatility characteristic and the short SPVXSTR leg could limit losses during quiet periods with high roll cost. Similar to the sizing methodology used for the SPVXMTR hedge, we size the long SPVXMTR leg by calculating the trailing six-month beta measured over overlapping weekly returns. The notional for the short SPVXSTR leg is kept to be one third of the SPVXMTR leg. This allows for the long SPVXMTR short SPVXSTR portfolio to have a positive exposure in most periods except when there is a significant volatility spike which could make SPVXSTR go up by more than 3 times the SPVXMTR return. In terms of performance, this has worked well as a hedge and has outperformed a long SPX position. While the hedge has performed well over the past 18 months and has the lowest carrying cost amongst the hedges considered in this publication, it underperformed SPVXSTR and SPVXMTR during the third quarter of 2008. We consider this a good hedge for relatively small moves in the market but would prefer a long position in SPVXMTR as a better tail hedge.

SPX Hedged with VIX Options
We consider three VIX options-based hedging strategies. We had discussed VIX options hedging strategies in detail in our publication: Index Volatility Weekly - VIX Options Trading Strategies: A Deep Dive – April 19, 2010.

SPX Hedged with VIX Calls (Figure 34)
VIX calls are a natural hedge for equity due to the negative correlation of VIX with equity prices and the convexity it offers. Each month we buy three-month 20% OTM call options to hedge the equity portfolio. The options are rolled after one month when the options have two months left to expiration. The underlying for the VIX three-month option is the corresponding three-month VIX futures. As we can see from Figure 20: Hedge Ratio of VIX Futures versus SPX, the hedge ratio of VIX three-month futures is approximately 0.4 on the basis of the last two-year history. Accordingly, we size the VIX options such that the notional amount of the VIX options is 40% of our equity portfolio. For example, if the equity position is $100 and the third month VIX future is $20, we will buy two VIX call options as equity hedge (100*0.4/20). The premium required to buy the option is borrowed each month at the Fed funds rate. Equity position is adjusted at each option expiration date

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according to the gain or loss from the option position and the interest incurred on the borrowing. While VIX call options lose money in most months, they work well in instances where equity markets experience large negative returns. In that respect they are much more of a tail hedge, which is why we prefer 20% OTM call options in comparison to ATM call options. It is also cheaper to carry longer-dated option since the implied volatility of VIX options has usually been the richest in the shorter end. In terms of performance they outperform long equity but underperform some other VIX option hedges that try to reduce the cost of the hedge by selling some other option in addition to the long call leg.

SPX Hedged with VIX Risk Reversals (Figure 35)
VIX call options are expensive due to the high implied realized volatility premium of VIX options. Cost of buying the call options can be reduced by selling OTM put options on VIX. Similar to the call hedge, we buy one-month 20% OTM call options to hedge SPX but also sell one-month 20% OTM put options on VIX to reduce the cost of the calls. The notional of VIX call options bought and put options sold is kept at 30% of the equity portfolio. The premium paid (or received) from buying and selling the options is borrowed (or deposited) at the Fed funds rate. Similarly, the equity position is adjusted according to the gain or loss from the option positions and the interest amount at each rebalance date. Historically, VIX has not had many spikes to the downside and even though OTM puts are cheaper than OTM calls, they are still a good sell, in our opinion. The risk of being short these puts is mitigated by the convexity of VIX to SPX which ensures that the downside to volatility is capped. In terms of performance, this works the best amongst the VIX optionsbased equity hedges.

SPX – Short VIX 1x2 Calls Spreads (Figure 36)
The reason we want to go long far OTM calls is that most spikes in volatility are very pronounced, which makes the far right tail a desirable part of the VIX distribution. In contrast, the intermediate part of the distribution is usually overpriced and a good sell. In other words, VIX usually goes up a lot or not at all. Selling a VIX 1x2 call spread allows for going long a far OTM call which is funded by selling a nearer call spread. The hedge will cost much less than a long VIX call and will work well during large volatility spikes. The risk to this strategy involves a positive drift for VIX. We implement this hedge in the three-month space which is cheaper to carry than the front month. Each month we sell three-month 120-150 VIX 1x2 call spread and roll it after one month to a new three-month option. Since this is based on a three-month future and not a front month future, we increase the hedge ratio to 0.4 from 0.3, which we had used for the front month future. The strategy does not cost much to carry but also gives lesser upside during crisis situations.

SPX Hedged with a Rolling SPX Put Spread Collar
We also show the performance of SPX hedged with a rolling put spread collar, which is one of the best performing conventional options-based strategies. The strategy involves buying a 12M 80%-95% SPX put spread each month with 1/12 the notional of the equity position

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and keeping the options to expiration. While this hedge outperforms a stand-alone long equity position, it underperforms most of the VIX ETNs and VIX options-based hedges.

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ALPHA STRATEGIES: METHODOLOGY
In the previous section we discussed how VIX options and VIX ETNs work well as equity hedges. While VIX products are attractive hedges, they also offer alpha opportunities due to the usually steep contango in VIX futures and the high volatility of VIX options. All the four strategies discussed below attempt to take advantage of one or more of these characteristics. We show the performance of all these strategies in the form of an index with daily prices. Since these are all different variations of a carry strategy, they are likely to experience drawdown risk flares. It becomes very important to correctly size these trades. Our aim is to be conservative in putting on risk so that it becomes very unlikely that the index will have outsized draw-downs. We look at the worst returns of each of these strategies over a rolling one-month period and size the trade such that it will roughly require four times the worst return for the index to go to zero. In other words, we are restricting the worst one-month draw-down historically to be around 25% of the index.

Short SPVXSTR Long SPVXMTR
In the report Index Volatility Weekly - Trading VXX versus VXZ – July 12, 2010, we showed how to monetize the VIX term structure premium through SPVXSTR and SPVXMTR. Selling SPVXSTR allows us to capture high roll yields present between the first and second month futures but it suffers from high draw-down when the volatility spikes. Buying SPVXMTR, along with selling SPVXSTR, reduces the draw-down and improves the performance considerably due to the flatter term structure between four- and seven-month VIX futures. We size the trade such that we go long $2 of SPVXMTR for every $1 short of SPVXSTR. The ratio of 2 is close to the average beta of SPVXMTR relative to SPVXSTR over a long history. The worst loss experienced by the strategy over a rolling one-month period is 50% of the SPVXSTR notional during October 2008. We therefore size the strategy such that we sell $50 of SPVXSTR and buy $100 of SPVXMTR at each rebalancing date for every $100 of equity in the portfolio. This limits the historical maximum draw-down to 25% of our strategy. The strategy is implemented in the form of a one-month total return swap with the equity being adjusted at the rebalance date (which is the VIX expiration date) according to the P/L of the swap. The strategy has performed well historically. One can think of the short SPVXSTR leg as the alpha part of the trade with SPVXSTR working well as a hedge.

Delta Hedged VIX Straddle
As discussed in the report Volatility of Volatility Risk Premium – February 16, 2010, a high implied realized premium exists in VIX options. One of the simplest ways to monetize this premium is by selling a VIX one-month delta hedged straddle. The risk to this trade is that subsequent one-month VIX volatility is much higher than the implied volatility. As can be seen from Figure 30, VIX ATM volatility trades at a roughly 50% premium to trailing realized volatility. We estimate that the highest realized volatility for front month VIX futures was ~250% during 2001 when the previous one-month volatility was only 50%. Using the above rule of thumb, the loss would have been 250 – 50*1.5 = 175
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volatility points. Assuming our rule of a maximum 25% draw-down, this would translate into a vega of ~0.15 per $100 of equity. As we have shown before, front month VIX options have historically been the most expensive, which makes them good candidates for selling delta hedged straddles. Each month we sell 0.15 Vega of ATM straddles for $100 of equity. The straddle is delta hedged on daily basis. The money received from selling the straddles is deposited at the Fed funds rate. The cash level is adjusted at the expiry for the gain or loss from selling the straddles and delta hedging them. It is interesting to note that the realized volatility of VIX options remains in a narrower band of its average implied volatility relative to SPX, where the divergence can be much greater. This makes selling VIX straddles attractive relative to a similar trade in SPX which also has a lower Sharpe ratio during the same period.

VIX 1x2 Put Spread
The usual steep term structure of VIX futures indicates that the VIX future would settle lower if the volatility term structure remains constant. In that regard, buying VIX put options allows for monetizing this roll down the curve. However, as was highlighted in the VIX straddle strategy, VIX options are usually expensive due to their high implied realized volatility premium. VIX 1x2 put spreads are short volatility of volatility and have a low tail risk due to the rarity of large downward moves in VIX. We had discussed the benefits of VIX 1x2 put spreads in our publication Index Volatility Weekly - VIX Options Trading Strategies: A Deep Dive – April 19, 2010. We select VIX one-month 80-100 1x2 put spread. The strikes were selected by comparing the historical performance of 1x2 put spread of different strikes. The cost of 1x2 put spreads has usually averaged 7% and the maximum loss experienced by the strategy would be limited to ~25% of the notional even in an extreme case of the front VIX future losing 60% of value in one month. In line with our methodology of limiting the one-month drawdown to 25%, we size the trade such that we buy ATM puts on a notional of $100 for every $100 of equity. Each month we buy the 1x2 put spreads with the notional of the long leg equalling our equity position. The cash outlay for buying the spread is borrowed at the Fed funds rate and the P/L of the strategy at the end of the month is added to the equity position. The strategy performance was flat to start off with but has performed well in 2009 and 2010.

VIX Calendar Spread
Another way to monetize the steep contango in VIX futures through VIX options is by going short a VIX put calendar spread (buy near-term put and sell longer-dated put). By buying a near-term put and selling a longer-term put of the same strike, we have a short position in near-term VIX future and long position in longer-dated VIX future, which is similar to the VXX versus VXZ trade. We buy the front month ATM put and sell the second-month put with the same strike. The trade in many ways is similar to the 1x2 put spread with the cost of buying the front month ATM put being funded by selling the longer maturity put. In the case of 1x2 put spreads, the cost of the ATM put was funded by selling lower strike puts. The risk to the
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calendar trade is for the term structure to invert with the longer-dated put being in the money while the shorter-dated put expires out of the money. However, the inversion of the term structure is usually associated with an increase in the levels of volatilities, which should result in even the second month options being out of the money. While it is difficult to estimate the possible losses in the trade, in many ways it is a less risky trade than the 1x2 put spread or the VXX vs. VXZ trade since an inversion of the surface is likely to be associated with a leg up for volatilities, which should keep the draw-down low. We size the trade similar to the 1x2 put spread with the notional of both front month and second month options equaling the cash held.

Short SPVXSTR Long VST1MT
In the report Index Volatility Weekly - Trading Volatility across the Pond – October 25, 2010, we discussed monetizing relatively higher VIX term structure premium through selling SPVXSTR and buying short-term VSTOXX futures index (VST1MT). The strategy benefits from the outperformance of VST1MT over SPVXSTR. This outperformance is more a result of the steeper term structure of SPX volatility relative to SX5E volatility than any divergence in the volatility levels of SPX and SX5E. We size the trade such that we go long $50 of VST1MT and short $50 of SPVXSTR for every $100 of index. The strategy is implemented in the form of a one-month total-return swap with the equity being adjusted at the rebalance date (which is the VIX expiration date) according to the P/L of the swap. Historically, the strategy has performed very well in most of the period from the beginning of 2006, apart from the period between March and December 2007. The underperformance in this period can be explained by the lag in the rise of volatility in Europe relative to the rise in the US. Ideally, P/L should be calculated using the prices of both the indices at the same time. Since we do not have a long enough history of intraday prices, we use closing levels of the indices to calculate the P/L. However, the calculation of P/L from closing prices leads to spurious noise, resulting in higher standard deviation and lower Sharpe ratio. In that regard, using weekly returns for calculating the Sharpe ratio leads to much better performance metrics.

Equal Volatility Combined Strategy
As discussed in the Volatility Outlook 2011- A Welcome Respite (For Now) - December 17, 2010 (page 67), the correlation between the different VIX alpha strategies is relatively low, with only the VIX 1x2 put spread and the VIX Calendars strategies having a high correlation between them. The low correlation between the strategies indicates that the strategies can be combined to achieve better risk-adjusted returns. We have used the trailing volatility of the strategies to size them, which leads to lower weights for strategies with high volatility. This method of combining the strategies results in better performance when predictability of correlation is low. The combined strategy is rebalanced every month at the VIX expiration dates to reassign weights to the strategies. At the VIX expiration date, the new weight assigned to each strategy is inversely proportional to the trailing three-month realized volatility of the strategy calculated using weekly overlapping returns.

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Historically, the combined strategy has achieved higher risk-adjusted returns and lower draw-downs compared to the other VIX strategies considered.

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SELECTED VIX-RELATED PUBLICATIONS
VIX Hedging Strategies: A 15-Year Perspective – June 3, 2011 – In this report, we calculate VIX option prices using the model developed in VIX Derivatives: A Poor Practitioner's Model, to examine the performance of these hedging strategies since 1996. The longer-time period also allows us to explicitly examine the performance of the strategies during different market regimes. VIX Derivatives: A Poor Practitioner's Model – May 19, 2011 – In this report, we construct a poor practitioner's model which relates the VIX volatility surface to the SPX volatility surface and historical VIX futures volatility. Index Volatility Weekly – Trading VXX options versus VIX options – May 02, 2011 – Similar to the short VIX Calendar strategy, buying VXX puts and shorting VIX is not negatively affected by the rich implied volatility and the rich skew of VIX options. Dynamic VIX ETN Strategy – January 20, 2011 – We discuss the construction of an intelligent long volatility index that is always long VXZ and switches between a long and short VXX position depending on the slope of the term structure. We also show that this dynamic VIX index has performed better as a hedge for a long SPX portfolio than other hedges considered (since 1996). Index Volatility Weekly - Trading Volatility across the Pond – October 25, 2010 – In this report, we investigate the performance of shorting VIX short term future and buying VSTOXX short-term futures through SPVXMT and VST1MT, respectively. Outperformance of VSTOXX short-term futures relative to VIX short term futures is due to higher term structure premium present in SPX volatility than SX5E volatility. Index Volatility Weekly - VXZ as a Tail Risk Hedge – September 27, 2010 – We extend our analysis of VXZ as a hedge for equity portfolio using a new constructed VXZ proxy to carry out detailed study of the strategy spanning 18 years. Index Volatility Weekly - Limited Downside to VIX – September 20, 2010 – We suggest attractive VIX options strategies utilising steep VIX term structure and the cheap volatility of VIX. Hedging Credit Portfolios – September 14, 2010 – We extend and enhance our analysis around the efficacy of using equity hedges for credit portfolio. We analyze and compare the performance of different hedging strategies for US and European IG and HY credit portfolios. Index Volatility Weekly - Whither Option Liquidity? – August 02, 2010 – We look at the broad liquidity trends in various volatility instruments, including SPX options, VIX ETNs, VIX Futures and VIX Options. We also analyze how bid-offer spreads fared in all these instruments during the volatility spike in May 2010. Index Volatility Weekly - VIX in Contango: A Slippery Slope – July 19, 2010 – In this report, we analyze the performance of the term flattening trades when VIX term structure is very steep. We show that it would be unwise to initiate a term flattening trade when VIX term structure is steep unless one believes the flattening is likely to happen in the near future. Index Volatility Weekly - Trading VXX versus VXZ – July 12, 2010 – We study the term structure premium present between the near and longer-dated SPX options. We compare the performance of monetizing the term structure premium versus the implied realized risk
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premium. We show how trading VIX futures through VXX and VXZ to monetize term structure premium is similar to monetizing this premium through variance swaps. Index Volatility Weekly - VIX Options Trading Strategies: A Deep Dive – April 19, 2010 – We present an extensive analysis of VIX option strategies for expressing views on volatility and hedging equity portfolios. We evaluate these strategies to analogous trades using SPX options. Hedging Credit Portfolios with VIX ETNs – April 06, 2010 – We analyze the performance of VIX ETNs (VXX and VXZ) along with SPX as hedges for investment grade (IG) and high yield (HY) credit portfolios. Understanding VIX ETNs Conference Call – March 08, 2010 – Through this conference call presentation, we address several important facets of VIX ETNs to facilitate better understanding of the VIX ETNs. VIX ETNS: A User's Manual – February 24, 2010 - In this report we collect the numerous queries we have fielded from investors around VIX futures ETNs (the VXX and VXZ). It is organized in the form of Frequently Asked Questions which should make it more convenient as a reference manual for investors. Volatility of Volatility Risk Premium – February 16, 2010 – Performance of systematically trading the premium between implied and subsequent realized volatility in options on VIX futures is analyzed. We compare the performance of selling VIX options relative to selling SPX options and quantify the effect of bid-offer spreads in VIX options on the performance of the strategy.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass Analyst Certifications We, Maneesh S. Deshpande and Rohit Bhatia, hereby certify (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. Important Disclosures The analysts responsible for preparing this report have received compensation based upon various factors including the Firm's total revenues, a portion of which is generated by investment banking activities. For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report, please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 1-212-526-1072. Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of research products, whether as a result of differing time horizons, methodologies, or otherwise. Risk Disclosure(s): Options are not suitable for all investors. Please note that the trade ideas within this report do not necessarily relate to, and may directly conflict with, the fundamental ratings applied to Barclays Capital Equity Research. The risks of options trading should be weighed against the potential rewards. Risks • Call or put purchasing: The risk of purchasing a call/put is that investors will lose the entire premium paid. •Uncovered call writing: The risk of selling an uncovered call is unlimited and may result in losses significantly greater than the premium received. •Uncovered put writing: The risk of selling an uncovered put is significant and may result in losses significantly greater than the premium received. •Call or put vertical spread purchasing (same expiration month for both options): The basic risk of effecting a long spread transaction is limited to the premium paid when the position is established. •Call or put vertical spread writing/writing calls or puts (usually referred to as uncovered writing, combinations or straddles (same expiration month for both options): The basic risk of effecting a short spread transaction is limited to the difference between the strike prices less the amount received in premiums. •Call or put calendar spread purchasing (different expiration months & short must expire prior to the long): The basic risk of effecting a long calendar spread transaction is limited to the premium paid when the position is established. Because of the importance of tax considerations to many options transactions, the investor considering options should consult with his/her tax advisor as to how taxes affect the outcome of contemplated options transactions. Supporting documents that form the basis of our recommendations are available on request. The Options Clearing Corporation's publication, "Characteristics and Risks of Standardized Options", is available at http://www.theocc.com/publications/risks/riskchap1.jsp Barclays Capital offices involved in the production of Equity Research: London Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London) New York Barclays Capital Inc. (BCI, New York) Tokyo Barclays Capital Japan Limited (BCJL, Tokyo) São Paulo Banco Barclays S.A. (BBSA, São Paulo) Hong Kong Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong) Toronto Barclays Capital Canada Inc. (BCC, Toronto) Johannesburg Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg) Mexico City Barclays Bank Mexico, S.A. (BBMX, Mexico City)

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Barclays Bank PLC-DIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence. Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporated outside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi (Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi). Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar Financial Centre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar. This material is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as defined by the DFSA, and Business Customers as defined by the QFCRA. This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option or advice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No.

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Barclays Capital | U.S. Derivatives Strategy: the VIX Compass 09141-37). Registered office Al Faisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number: 1010283024. This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker License #177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21. This material is distributed in India by Barclays Bank PLC, India Branch. This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. For matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles Quay Level 28, South Tower, Singapore 048583. Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined by Australian Corporations Act 2001. IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be tax advice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot be used, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matters addressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor. Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication and such information is not incorporated by reference. © Copyright Barclays Bank PLC (2011). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of Barclays Capital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional information regarding this publication will be furnished upon request.

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