CME Looks To Options Debut As Turning Point For Oil `Fear Index'

CME Group Inc. (CME) is betting that options contracts tied to a new measure of oil market volatility will finally get traders interested in a "fear index" for oil.

The oil volatility index, or VIX, modeled off of the popular Standard & Poor's 500 volatility index, was released in October. Both offer a gauge of the severity of price swings and allow investors to bet on how volatile prices will be. But the oil VIX has garnered little interest from market participants since its inception.

CME is hoping that options contracts linked to the index, which are set for release in the first quarter of 2011, will generate a surge of interest similar to the exponential growth seen in S&P 500 VIX contracts when it unveiled options in 2006.

The success of the oil VIX will be an important test for CME, the world's largest futures exchange operator, as to whether commodities investors will show the same interest in fear as their compatriots in the stock market. In March, the exchange forged a seven-year agreement with the Chicago Board Options Exchange to develop volatility measures on CME's most popular commodities markets. Gold futures have an index as well, and VIX for corn and soybeans are on the way.

"The initial interest is going to come from funds and banks and institutional players," said CME Group's Julie Winkler, Managing Director of Research and Product Development. "It will be similar to what we saw on the equities side ... by the nature of the product, it's much cleaner to express their opinions in the options."

A volatility index measures price swings in an underlying security based on the price difference between put and call options, or bets that a security will fall or rise in value. Investors can then use options based on the index itself to wager on how severe those swings will be.

Hundreds of thousands of derivatives contracts tied to the S&P 500 VIX trade daily. Derivatives are financial contracts such as futures or options, linked to the value of an underlying asset, like a company's stock or a barrel of oil, or another derivative.

Just as the CBOE set out to do with option contracts tied to the S&P's volatility, by creating options tied to the oil VIX, CME hopes to create a new way for investors to hedge against rapid changes in oil prices. The contracts could also be used by oil producers and consumers as part of a broader price-hedging strategy.

So far, investors don't have much use for the new VIX. Futures tied to the index haven't seen any trading activity, and few traders or brokers have had any interest from clients.

"None of our customers have even asked about it," said Kurt Kinker, a senior market analyst at Mirus Futures in Chicago.

Investors, producers and consumers don't like entering markets with few other participants, since it's more difficult to unload their positions. If oil VIX options remain as unpopular as the futures tied to the oil VIX, the contracts could fester in obscurity like many other thinly-traded derivatives.

VIX products generated $6.4 million in fees for the CBOE in the third quarter, and more than $120 billion in contracts have traded this year, according to the CBOE.

Winkler isn't discouraged by the lack of VIX-futures trading, pointing to the history of the S&P 500 VIX as a roadmap for how a market could develop.

S&P VIX futures began trading in 2004, but saw little interest until the exchange offered options in February 2006. Two months later, in April, average daily options volume was 15,052 contracts. By mid-May, 150,000 options contracts had traded in a single session.

Of course, interest in volatility indices is often piqued when markets appear more volatile, and since the oil VIX began, oil markets have remained calm.

Oil futures settled at $88.02 a barrel Friday, up just 8% from the end of October, when futures settled at $81.43 a barrel.

-By Jerry A. DiColo, Dow Jones Newswires, 212-416-2155; jerry.dicolo@dowjones.com

--Brendan Conway contributed to this article

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