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Bill Speth, CBOE

CBOE launches Smile Index based on implied volatilities of S&P 500 options


Chicago Board Options Exchange (CBOE) has launched the CBOE S&P 500 Smile Index, a premium-capture strategy benchmark index based on the steepness of the curve of implied volatilities of S&P 500 Index (SPX) options.

The CBOE Smile Index's strategy alternates between selling a strangle (sell put/sell call) when the options smile is steep, and selling a risk reversal (sell put/buy call) when the options smile is relatively flat.
 
Historically, a flatter smile has been associated with market bottoms and suggests a higher probability of a market upturn.
 
Constructed to perform in both bull and bear markets, the CBOE Smile Index takes its directional cue from the steepness of the smile as gauged by the ratio of put-to-call prices for SPX options, as an alternative to implied volatility. 
 
If the put-to-call ratio is smaller than or equal to 1.5, it suggests a flatter smile and one 25 delta put is sold and one 25 delta call is bought. If the ratio is greater than 1.5, it suggests steepening and a 25 delta call is sold instead.
 
The index is designed to then overlay the 25 delta put and 25 delta call options position with one-month Treasury bills to collateralise the position.
 
Delta is a risk measure commonly used by option traders that compares the potential change in price of the underlying asset with the corresponding change in the price of a derivative. 
 
"Hedge funds, portfolio managers and individuals who trade derivatives products are looking for ways to enhance yields in the current low-interest-rate environment," says Bill Speth (pictured), vice president of research at CBOE. "The CBOE Smile Index offers these investors another tool to take action based on the current market outlook."

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