Volatility products at Eurex Exchange. February 7, 2012

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1 Volatility products at Eurex Exchange

2 Volatility Products at Eurex Exchange Agenda Introduction Properties of volatility Eurex products, liquidity and volume VSTOXX strategies at a glance Further information and contacts 2

3 Volatility Products at Eurex Exchange Introduction A volatile world Front Month Euro Bund prices versus 30 Day historical volatility y itraxx Europe Composite Spread vs. Markit VolX Europe Index 5Y - 20 Day Index* % 160% 140% 120% 100% 80% 60% 40% 20% 0% Sum of Composite Spread Sum of Markit VolX Europe Index 5Y - 20 Day Index Is sovereign really AAA? Who can repay? Who needs EFSF? Who needs a haircut? Flight to quality drove Euro Bund prices higher. And volatility is a long way from its historic range of 4 to 6 percent. Credit spreads are far from stable, and have proven to be an omen for things to come. Repeated volatile periods have posed challenges for investors. * Source: Markit TM 3

4 Volatility Products at Eurex Exchange Introduction Volatility, how many ways art thou to trade thee Equity Index Options, for example, EURO STOXX 50 options at Eurex Path dependency does not provide pure volatility exposure. Highly liquid, but dynamic delta hedging involved is not preferred by everyone. Variance / Volatility Swaps Expiration to realized. OTC trading involves credit risk. Listed volatility products, for example, VSTOXX Futures and Options Expire to a forecast. Good replication with transparent index concept. 4

5 Volatility Products at Eurex Exchange Introduction EURO STOXX 50 Volatility VSTOXX index concept VSTOXX Index is based on Eurex EURO STOXX 50 Index Options. The VSTOXX index does NOT measure implied volatilities of ATM options, but the implied variance across all options of given time to expiry. The main index VSTOXX is designed as a rolling index at a fixed 30 days to expiry through linear interpolation of the two nearest of the eight available sub-indexes. The sub-indexes represent the eight expiry months with a maximum of two years and are calculated every five seconds. 5

6 Volatility Products at Eurex Exchange Introduction EURO STOXX 50 Volatility VSTOXX index concept The model aims at making pure volatility tradable, i.e. the index should be trackable by a portfolio which does not react to price fluctuations, but only to changes in volatility. This is not achieved through volatility, but through variance (volatility squared). Price screens and filters All option prices that are one-sided or either a bid or an ask or options without a bid or ask at all, are screened out. Only options that are quoted within the established maximum spread are eligible. Cutting the wings exclusion of option prices: this filter ensures that prices used do not fall short of minimum value of 0.5 index points. Options that are too far OTM and therefore do not have much influence on the result of the calculation are filtered out as well. 6

7 Volatility Products at Eurex Exchange Agenda Introduction Properties of volatility Eurex products, liquidity and volume VSTOXX strategies at a glance Further information and contacts 7

8 Volatility Products at Eurex Exchange Properties of volatility Properties of volatility 1. Negative correlation with equity markets 2. Sudden positive spikes 3. Mean reversion 4. Volatility risk premium 5. Slide costs 8

9 Volatility Products at Eurex Exchange Properties of volatility 1. Underlying & volatility strong negative correlation 9

10 VSTOXX Level Volatility of Volatility Volatility Products at Eurex Exchange Properties of volatility 2. Sudden spikes in different volatility regimes VSTOXX Index versus 30 day hist. volatility of VSTOXX Single event caused spike in volatility earthquake Realization of anticipated events: US downgrade and further euro worries 180% 160% 140% 120% Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan % 80% 60% 40% 20% 0% 30 Day VSTOXX Index VSTOXX Index - Historical 30 Days Volatility When volatility is low, sudden spikes in volatility may end a period of stable equity returns and low volatility. When volatility is high, volatility of volatility is yet higher, and the VSTOXX is subject to more severe changes in value. 10

11 Volatility Products at Eurex Exchange Properties of volatility 3. Mean reversion (historical VSTOXX levels) EURO STOXX 50 Index versus VSTOXX EURO STOXX 50 VSTOXX When volatility is high, it can stay high, or trend back down to a long-term mean. 11

12 Volatility Products at Eurex Exchange Properties of volatility 4. Implied volatility is usually higher than realized 60% VSTOXX versus realized volatility of EURO STOXX 50 Index 50% 40% 30% 20% 10% 0% Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 VSTOXX Index SX5E 30 Day Hist. Volatility Notwithstanding the 30 day calculation lag of realized volatility, implied volatility of EURO STOXX 50 options resulting in the VSTOXX index is higher than realized volatility. 12

13 Volatility Products at Eurex Exchange Properties of volatility 5. Slide costs, or costs that (can) make money Contango Backwardation When longer-dated volatility is higher than shorter-dated, it may seem appealing to capture the volatility risk premium by shorting volatility of longer dated contract months. Which is a highly successful strategy, until times change and a shock or change in volatility regime takes place. 13

14 Volatility Products at Eurex Exchange Agenda Introduction Properties of volatility Eurex products, liquidity and volume VSTOXX strategies at a glance Further information and contacts 14

15 Volatility Products at Eurex Exchange Eurex products, liquidity and volume Product specifications Symbol OVS FVS Product Name VSTOXX Options VSTOXX Mini Futures Underlying The VSTOXX Index, a market estimate of expected volatility that is calculated every 5 seconds by using real-time EURO STOXX 50 option bid/ask quotes. Contract Value EUR 100 per index point of the underlying EUR 100 per index point of the underlying Price Quotation and Minimum Price Change Contract Months Exercise Price Intervals Exercise Settlement Daily Settlement Price Last Trading Day and Final Settlement Day Final Settlement Price In points with two decimal places. The Minimum Price Change is 0.05 points (equivalent to a value of EUR 5). The three nearest calendar months and the following quarterly month of the February cycle Staggered by Volatility Index Level: = < 20-1 Index Point > 20 and =< Index Points > 50-5 Index Points European-style; an option can only be exercised on the Final Settlement Day of the respective option series until 21:00 CET The next eight successive calendar months Cash settlement, payable on the first exchange day following the Final Settlement Day. Established by Eurex, determined through the Black/Scholes 76 model Determined during the closing auction of the respective futures contract. 30 calendar days prior to the third Friday of the expiration month of the underlying options. This is usually the Wednesday prior to the second last Friday of the respective expiration / maturity month. Average of the VSTOXX values on the Last Trading Day between 11:30 and 12:00 CET. EurexOTC: Block Trade Size 500 Contracts 1,000 Contracts Vendor Codes Bloomberg: V2X INDEX OMON Bloomberg: V2X INDEX CT 15

16 Traded Contracts Volatility Products at Eurex Exchange Eurex products, liquidity and volume Volatility futures Volume and open interest* Open Interest Order Book Volume OTC Volume Institutional interest for European volatility product remains high with an increasing number of structured products on VSTOXX and market players facilitating execution. Daily average volume over 8,000 contracts in Q4/2011, while open interest lies at 80,000 contracts. * As of January 20,

17 Volatility Products at Eurex Exchange Eurex products, liquidity and volume Volatility options Volume and open interest* In 2010 Eurex expanded its volatility segment with the launch of VSTOXX options. Options screen quotation is provided by Societé Generale (since October 2011). * As of January 20,

18 Options Futures Volatility Products at Eurex Exchange Eurex products, liquidity and volume Liquidity overview for volatility derivatives VSTOXX futures are quoted up as tight as 0.25 volatility index points, reflecting a volatility spread of circa 0.5 percent Market depth shows further size Typically all four option expiries are quoted onscreen. Traded volume since launch 1 000,000*. Open interest at 85,000*. * As end of January 19,

19 Volatility Products at Eurex Exchange Agenda Introduction Properties of volatility Eurex products, liquidity and volume VSTOXX strategies at a glance Further information and contacts 19

20 Volatility Products at Eurex Exchange VSTOXX strategies Why trade volatility derivatives? Hedge your portfolio exposure, especially as a disaster hedge equity portfolios credit portfolios options portfolios Diversify your portfolio by adding a new asset class. Investments based on active benchmark strategies require a frequent rebalancing, driving costs up Negative correlation of the VSTOXX to the EURO STOXX 50 offsets rebalancing costs. 20

21 Volatility Products at Eurex Exchange VSTOXX strategies Why trade volatility derivatives? Equity funds are short volatility Equity falls, volatility rises. Equity put positions can be substituted by a position in a volatility call, offsetting a decline in the equity by a rise in the volatility position. Position taking on future volatility levels with volatility options limits downside risk to paid premiums for outrights or option spread positions. Directional trading/speculation on the level of a single volatility index. Speculation on spreads between volatility indexes. Mean reverting nature of volatility index can generate additional alpha. Dispersion Trading. 21

22 Volatility Products at Eurex Exchange VSTOXX strategies Why the VSTOXX? VSTOXX features a more pronounced negative correlation to European equities than other volatility measures. The average 6M correlation of weekly returns was between the VSTOXX and EURO STOXX 50, compared to between the VIX and EURO STOXX 50 Although the correlation of VSTOXX and VIX is very high, the two indexes price risks in different regions, which have differing specific drivers higher concentration of constituent stocks: 50 versus 500 higher realized volatility of financials in VSTOXX Euro specific risk prevalent with sovereign debt crisis Exploit relative value opportunities between the VSTOXX and the VIX. 22

23 Volatility Products at Eurex Exchange VSTOXX strategies How many futures do I need? The optimal hedge ratio Let s assume an investor runs a 10 Mio portfolio of index exposure in the EURO STOXX 50 (ESX50) index: A 1 percent drop of the ESX50 index triggers an increase of 45bp in the FVS 1-month and 12bp in the 6-month future (based on regression analysis) A 1 percent fall of the index costs our investor Possible hedging solutions: the FVS delivers 100 Vega exposure per contract, therefore the hedge ratio should be as follows: a) FVS 1 Mth: / 0.45/ 100 = futures b) FVS 6 Mth / 0.12/ 100 = futures c) OVS Mar Put 1.75* index points (Spot at 26.45) Sell 1000 puts 100 * 1.75* = * Please consider that the OVS calculation does not incorporate any drastic changes of the option prices due to the vol-vol impact 23

24 Volatility Products at Eurex Exchange VSTOXX strategies VSTOXX futures directional trading strategies It is June 23, 2011 and an investor believes that the US downgrade will negatively affect equities A long position in VSTOXX futures is entered to hedge equity positions Long 1,000 FVS Aug 24.4 It is Sept 23, 2011 and VSTOXX December 2011 Futures contracts are trading at index points A short position in VSTOXX futures is entered in expectation of retreating closer to its long-term mean Short 100 FVS Dec On August 5 the investor s price target of 35 is breached, and the position is closed out at ( ) * 100 * 100 contracts = 107,500 On October 27 investor s down side price target of 35 is taken, and the position is closed out at ( ) * 100 * 100 contracts = 53,000 24

25 Volatility Products at Eurex Exchange VSTOXX strategies Out of the money VSTOXX Puts Motivation On November 2, 2011, the November 2011 VSTOXX Futures is at and November 2011 VSTOXX Puts are trading at 4.00 volatility index points. Anticipating extended higher volatility, the investors sells 1,000 VSTOXX Puts November 2011 expiry with an exercising of The trade Sell 1,000 November 11 VSTOXX Puts at 4.00 index points Premium income 4.00 * 100 EUR * 1,000 contracts = 400,000 EUR Result During the three weeks until expiry, the Nov 11 VSTOXX futures stayed high, and expired at Puts expired in the money, and nearly the entire premium was earned Premium Diff(Exercise price FSP) = 4.00 ( ) = = 2.79 points = 279,000 25

26 Volatility Products at Eurex Exchange Agenda Introduction Properties of volatility Eurex products, liquidity and volume VSTOXX strategies at a glance Further information and contacts 26

27 Volatility Products at Eurex Exchange Marketmaking Screen Market Makers Company Contact Person Phone Societe General VSTOXX Options Screen and Phone Market Maker Alastair Beatie Brice Abbou Barclays Capital VSTOXX Mini Futures & Phone Market Making for VSTOXX Options Gabriel Manceau Dominicé & Co Asset Management (VSTOXX Mini Futures) Pierre de Saab

28 Volatility Products at Eurex Exchange VSTOXX strategies Observed VSTOXX option trading strategies VSTOXX Options Strategy Key Features / Anticipation Advantages Limitations Out of the Money VSTOXX Calls Directional rise in volatility Only premium at risk Upside calls typically priced at higher Vol of Vol Call/Put Spreads Directional move in volatility Rise in Vol of Vol Rich out of the money calls reduce premium outlay Capped upside not suitable to hedge tail risk VSTOXX Conversion Directional, synthetic exposure to VSTOXX Long Call captures spikes, while the Short Put sees smoother declines in volatility VSTOXX Straddle Move in volatility to be lower than generated premium Capture difference between realized and implied Vol of Vol by shorting straddle Vol of vol can spike much more than volatility High premium VSTOXX Ratio Put Spread Directional, but limited move in VSTOXX to upper/lower strikes shorted Utilize skew of VSTOXX options Exposure to volatility surges VSTOXX Call / Put Butterfly Move in Vol of Vol Pinpoint VSTOXX level at expiry Reduced premium outlay Reduced risk upon significant volatility move More legs to trade Out of the Money VSTOXX Puts Directional rise in volatility Long Volatility and generates premium Underperformance after volatility shock 28

29 Volatility Products at Eurex Exchange Information and contacts Further information Delayed Quotes & Daily Volumes Factsheets Flyer Document Center 29

30 Volatility Products at Eurex Exchange Information and contacts VSTOXX calculation 30

31 Volatility Products at Eurex Exchange Further information Contact us Sales Frankfurt Sales Paris Sales Zurich France Schuster Eurex Frankfurt AG Frankfurt Germany P: +49 (0) F: +49 (0) france.schuster@eurexchange.com Paul Beck Deutsche Börse AG Representative Office France 17, rue de Surène Paris France P: +33 (0) F: +33 (0) paul.beck@eurexchange.com Markus-Alexander Flesch Eurex Zürich AG Selnaustrasse Zürich Switzerland P:+41 (0) F:+41 (0) markus-alexander.flesch@eurexchange.com Sales UK Sales Americas Sales Asia & Middle East Stuart Heath Deutsche Börse AG UK Representative Office One Canada Square, Canary Wharf London, E14 5DR United Kingdom P: +44 (0) F: +44 (0) stuart.heath@eurexchange.com Vassilis Vergotis Eurex 233 South Wacker Drive - Suite 2450 Chicago, IL USA P: F: vassilis.vergotis@eurexchange.com Roland Schwinn Eurex Frankfurt AG 50 Raffles Place No Singapore Land Tower Singapore P: F: roland.schwinn@eurexchange.com 31

32 Volatility Products at Eurex Exchange Eurex 2012 Deutsche Börse AG (DBAG), Clearstream Banking AG (Clearstream), Eurex Frankfurt AG, Eurex Clearing AG (Eurex Clearing) as well as Eurex Bonds GmbH (Eurex Bonds) and Eurex Repo GmbH (Eurex Repo) are corporate entities and are registered under German law. Eurex Zürich AG is a corporate entity and is registered under Swiss law. Clearstream Banking S.A. is a corporate entity and is registered under Luxembourg law. U.S. Exchange Holdings, Inc. and International Securities Exchange Holdings, Inc. (ISE) are corporate entities and are registered under U.S. American law. Eurex Frankfurt AG (Eurex) is the administrating and operating institution of Eurex Deutschland. Eurex Deutschland and Eurex Zürich AG are in the following referred to as the Eurex Exchanges. All intellectual property, proprietary and other rights and interests in this publication and the subject matter hereof (other than certain trademarks and service marks listed below) are owned by DBAG and its affiliates and subsidiaries including, without limitation, all patent, registered design, copyright, trademark and service mark rights. While reasonable care has been taken in the preparation of this publication to provide details that are accurate and not misleading at the time of publication DBAG, Clearstream, Eurex, Eurex Clearing, Eurex Bonds, Eurex Repo as well as the Eurex Exchanges and their respective servants and agents (a) do not make any representations or warranties regarding the information contained herein, whether express or implied, including without limitation any implied warranty of merchantability or fitness for a particular purpose or any warranty with respect to the accuracy, correctness, quality, completeness or timeliness of such information, and (b) shall not be responsible or liable for any third party s use of any information contained herein under any circumstances, including, without limitation, in connection with actual trading or otherwise or for any errors or omissions contained in this publication. This publication is published for information purposes only and shall not constitute investment advice respectively does not constitute an offer, solicitation or recommendation to acquire or dispose of any investment or to engage in any other transaction. This publication is not intended for solicitation purposes but only for use as general information. All descriptions, examples and calculations contained in this publication are for illustrative purposes only. Eurex and Eurex Clearing offer services directly to members of the Eurex exchanges respectively to clearing members of Eurex Clearing. Those who desire to trade any products available on the Eurex market or who desire to offer and sell any such products to others or who desire to possess a clearing license of Eurex Clearing in order to participate in the clearing process provided by Eurex Clearing, should consider legal and regulatory requirements of those jurisdictions relevant to them, as well as the risks associated with such products, before doing so. Eurex derivatives (other than EURO STOXX 50 Index Futures contracts, EURO STOXX Select Dividend 30 Index Futures contracts, STOXX Europe 50 Index Futures contracts, STOXX Europe 600 Index Futures contracts, STOXX Europe Large/Mid/Small 200 Index Futures contracts, EURO STOXX Banks Futures contracts, STOXX Europe 600 Banks/Industrial Goods & Services/Insurance/Media/Personal & Household Goods/Travel & Leisure/Utilities Futures contracts, Dow Jones Global Titans 50 IndexSM Futures contracts, DAX Futures contracts, MDAX Futures contracts, TecDAX Futures contracts, SMIM Futures contracts, SLI Swiss Leader Index Futures contracts, Eurex inflation/commodity/weather/property and interest rate derivatives) are currently not available for offer, sale or trading in the United States or by United States persons. 32