eurex exchange’s vstoxx ® products: trading and applications june 04, 2011

Eurex Exchange’s VSTOXX® products: Trading and applications

June 04, 2011

2www.eurexchange.com

Volatility products at Eurex Exchange June, 2011

2

Agenda

• Eurex Exchange’s volatility products• Trading opportunities• Further information and contacts



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Underlying & volatility

EURO STOXX50® / VSTOXX®

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500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Dec-05

Feb-0

6

Apr-0

6

Jun-

06

Aug-0

6

Oct-06

Dec-06

Feb-0

7

Apr-0

7

Jun-

07

Aug-0

7

Oct-07

Dec-07

Feb-0

8

Apr-0

8

Jun-

08

Aug-0

8

Oct-08

Dec-08

Feb-0

9

Apr-0

9

Jun-

09

Aug-0

9

Oct-09

Dec-09

Feb-1

0

Apr-1

0

Jun-

10

Aug-1

0

Oct-10

Dec-10

Feb-1

1

Apr-1

1

0

10

20

30

40

50

60

70

80

90

100

VSTOXX®

EURO STOXX 50®

Strong negative correlation



• Calculation for the VSTOXX® Index is based on Eurex Exchange’s 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 2 nearest of the 8 available sub-indexes.

• The sub-indexes represent the eight expiry months with a maximum of 2 years and are calculated every 5 seconds.

• 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)

EURO STOXX 50® volatility (1/2)Index concept of the VSTOXX®



• 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.

EURO STOXX 50® volatility (2/2)Index concept of the VSTOXX®



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Symbol OVS FVS

Product name VSTOXX® Options VSTOXX® Mini FuturesUnderlying The VSTOXX® Index, a market estimate of expected volatility that is calculated every five seconds by using real-

time EURO STOXX 50® Index option bid/ask quotes. Contract value EUR 100 per index point of the underlyingPrice quotation and MinimumPrice Change

In points with two decimal places. The Minimum Price Change is 0.05 points (equivalent to a value of EUR 5).

Contract months The three nearest calendar months and the following quarterly month of the February, May, August and November cycle

The eight nearest successive calendar months

Exercise price intervals Staggered by volatility index level: = < 20 - 1 index point> 20 and =< 50 - 2.5 index points> 50 - 5 index points

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Exercise European-style; an option can only be exercised on the Final Settlement Day of the respective option series until 21:00 CET

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Settlement Cash settlement, payable on the first exchange day following the Final Settlement Day.

Daily Settlement Price Established by Eurex, determined through the Black/Scholes 76 model.

Determined during the closing auction of the respective futures contract.

Last Trading Day and FinalSettlement Day

30 calendar days before the third Friday of the expiration month of the underlying options. This is usually the Wednesday before the second last Friday of the respective expiration / maturity month.

Final Settlement Price Average of the VSTOXX® values on the Last Trading Day between 11:30 and 12:00 CET.Block Trade size 500 contracts 1,000 contractsVendor codes Bloomberg: V2X Index OMON

Reuters: 0#FVS+Bloomberg: FVSA Index Reuters: 0#FVS:

Product specifications



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• In June 2009, Eurex Exchange re-launched its volatility product offering with the launch of VSTOXX®

Mini Futures. A new contract with a reduced tick size of EUR 100 per index point (formerly EUR 1,000) was introduced in response to market demand.

• In May 2011, open interest in VSTOXX® Mini Futures stands at 60,000.

• Daily trading volume in VSTOXX® Mini Futures lies at 5,000 contracts in 2011.

• More than 50 exchange members are now trading VSTOXX® Mini Futures.

• In Q1 2011, ten new members started trading, mainly client flow.

Volatility index futures (1/2)

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11 May-11

Tra

ded

Co

ntr

acts

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

Op

en In

terest

Order Book Volume OTC Volume Open Interest* As of May 23, 2011

Volume and open interest*



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Volatility index futures (2/2)

Key Drivers:• Issuance of European ETNs linked to the index VSTOXX® and also directly to VSTOXX®

Mini Futures by market participants create trading and hedging demand from these issuers. • A number of proprietary trading firms have entered VSTOXX® Mini Futures, trading against

clients flows, with arbitrage strategies against EURO STOXX 50® Index Options and in light of designated sponsoring activities in ETNs.

• Six Banks are successfully offering execution of futures block trades to clients in larger trade sizes, also as an exchange listed trading alternative to OTC variance swaps.




0

20.000

40.000

60.000

80.000

100.000

120.000

140.000

160.000

180.000

200.000

Mai 10 Jun 10 Jul 10 Aug 10 Sep 10 Okt 10 Nov 10 Dez 10 Jan 11 Feb 11 Mrz 11 Apr 11 Mai 11

Tra

ded

Co

ntr

act

s

0

20.000

40.000

60.000

80.000

100.000

120.000

140.000

Op

en In

terest

Order Book Volume OTC Volume Open Interest

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• On March 22, 2010 Eurex Exchange expanded its volatility offering with the launch of VSTOXX® Options.

• Screen pricing is provided by J.P. Morgan, five further banks facilitate client trading interest.

• In the first year of trading, 760,000 VSTOXX® Options were traded.

• In 2011, daily average options volume lies at 2,500 contracts.

Volatility index options

* As of May 23, 2011




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Agenda




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Volatility – an effective portfolio diversification?

• In an academic study from July 2009, ‘VIX Futures and Options – A Case Study of Portfolio Diversification During the 2008 Financial Crisis’, Edward Szado / CISDM found that:

– Inclusion of VIX Futures to portfolios of equity/bonds/alternative investments* under analysis during the 2008 Financial Crisis both increased returns and reduced standard deviation by almost 1/3.

– Inclusion of ATM VIX Calls to the portfolio also increased portfolio returns but the effect on standard deviation was mixed with a slight increase. The results showed greater return benefits in market drops but a corresponding increase in standard deviation.

– Even with only a 1 per cent allocation of ATM VIX Calls efficient frontier moves higher with a lower risk and higher return, therefore such a combination may provide a significant protection in downturns and investable volatility products could have been used to provide some much needed diversification during the crisis.

* The portfolio is 60.5 per cent equity; 30.5 per cent bonds and 9 per cent alternative assets like RE, High Yield, HF, MF and PE.



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• pPF consists of long 3-month futures on EURO STOXX 50® (FESX).• cPF consists of 30 per cent long one-month futures on VSTOXX® (FVSX) and of 70 per cent long three-

month futures on EURO STOXX 50® Index (FESX).• Rebalancing once a week.

Futures on VSTOXX® (FVSX & FVS) and Futures on EURO STOXX 50® Index (FESX)

Portfolio diversification with volatility index futures

Combined Portfolio (cPF) vs. Pure Portfolio (pPF)

0%

100%

200%

300%

400%

500%

Rebased cPF

Rebased pPF



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• 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.

Volatility derivatives (1/2)Trading opportunities



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• 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.

Volatility derivatives (2/2)Trading opportunities



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Observed VSTOXX® Options trading strategies and characteristics

VSTOXX® Options strategy Key features / Anticipation Advantages Limitations

OTM VSTOXX® Calls Directional rise in volatility Only premium at riskUpside calls typically priced at higher Vol of Vol

Call/Put SpreadsDirectional move in volatilityRise in Vol of Vol

Rich out of the money calls reduce premium outlay

Capped upside not suitable to hedge tail risk

VSTOXX® ConversionDirectional, 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 SpreadDirectional, but limited move in VSTOXX® to upper/lower strikes shorted

Utilize skew of VSTOXX® Options Exposure to volatility surges

VSTOXX® Call / Put ButterflyMove in Vol of VolPinpoint VSTOXX® level at expiry

Reduced premium outlay Reduced risk upon significant volatility move

More legs to trade

OTM VSTOXX® Puts Directional rise in volatilityLong volatility and generates premium

Underperformance after volatility shock



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OTM VSTOXX® Calls

Motivation: • On April 27, 2010 the May 2010 VSTOXX® Mini Futures are trading at 27.60• Investor looks to profit from anticipated increase in volatility until expiry and buys VSTOXX® Calls

The trade: • Buy 1,000 contracts of May 32.50 VSTOXX® Options

@ 0.90 index points• Total premium outlay amounts to

0.90 * EUR 100 * 1,000 contracts = EUR 90,000

Performance: • VSTOXX® Calls performed well as the VSTOXX® and respective VSTOXX® Mini Futures contract month

increased• Position was closed prior to expiry on May 7 for 10.2 index points • Total profit was 9.3 * EUR 100 * 1,000 contracts = + EUR 930,000

VSTOXX Futures May 2010 Contract

25

30

35

40

45




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VSTOXX® Call Spread

Motivation: • Investor sees volatility breakout of May 2010 as over and wishes to profit from receding volatility from

its current level of 34.20 for June VSTOXX® Mini Futures with downside VSTOXX® Put. To reduce premium outlay, two OTM Puts are sold at a lower exercise price

The trade: • Buy 3,000 May 30.00 VSTOXX® Calls @ 4.55 index points• Sell 3,000 May 32.50 VSTOXX® Calls @ 3.40 index points• Total premium outlay amounts to

1.15 * EUR 100 * 3,000 contracts = EUR 345,000

Performance: • May VSTOXX® final settlement was 43.18• Difference in exercise prices of 2.5 stands against initial net premium of 1.15 index points• Total profit was 1.35 * EUR 100 * 3,000 contracts = + EUR 405,000


25

30

35

40

45




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Agenda




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* Currently the quoted spread in VSTOXX® Mini Futures is less than one per cent of the bid price.

Market-Making

VSTOXX® Mini Futures VSTOXX® Options

Minimum contract size 500 contracts 25 contracts

Maximum spread*5 per cent of bid price,i.e. future bid = 25 per cent, thus spread ≤ 125 bps

Bid up to 2 max spread 0.40 pointsBids from 2 to 20 20 per cent of bid pricei.e. option bid = 4.00, thus a spread ≤ 80 bpsBid > 20 max spread 4 points

Required coverage80 per cent of the total trading period on a monthly average.

70 per cent of the total trading period on a monthly average for calls and puts in five out of nine exercise prices around the current index level. Asymmetric quotation is allowed.

Maturity/expiry range All eight maturities have to be covered All four expirations have to be covered

Incentive 100 per cent free rebate for trades on M-account from March 1, 2010 until December 31, 2011, for fulfilling monthly obligations

100 per cent free rebate for trades on M-account from March 22, 2010 until December 31, 2011, for fulfilling monthly obligations. Eurex Exchange will also grant a revenue sharing and distribute 50 per cent of the net trading fee among the top three performing Market Makers on a monthly basis. The kickback is determined as a ration of the trading volume of the three Market Makers.

Volatility derivatives



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Market-Makers

Company Contact Phone

J.P. Morgan (VSTOXX® Options Screen and Phone Market Maker)

Index Desk +44-20-73 25-63 95

Barclays Capital (VSTOXX® Mini Futures & Phone Market Making for VSTOXX® Options)

Joshua Spitz +44-20-77 73-92 64

Dominicé & Co Asset Management (VSTOXX® Mini Futures)

Pierre de Saab +41-22-319-21 74



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Further information

Factsheets: • www.eurexchange.com > Documents > Publications > Eurex OTC Volatility Strategy with

Cash Equity Leg • www.stoxx.com/indices/factsheets/eurozone.html

Flyer:• www.eurexchange.com > Documents > Publications > Flyer_Volatility_Index_

Derivatives.pdf

Webinfos:• http://www.eurexchange.com/trading/products/VOL_en.html



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Contact us

• Sales Continental Europe

France Schuster

Eurex Frankfurt AGMergenthalerallee 6165760 EschbornGermany

P: +49 (0)69 2 11-1 52 38F: +49 (0)69 2 11-61 52 38

[email protected]

Paul Beck

Deutsche Börse AGRepresentative Office France17, rue de Surène75008 ParisFrance

P: +33 (0)155 2 76-7 72F: +33 (0)155 276-7 50

[email protected]

Markus-Alexander Flesch

Eurex Zürich AGSelnaustrasse 308021 ZürichSwitzerland

P: +41 (0)58 8 54-29 48F: +41 (0)58 8 54-24 66

[email protected]

Sales UK Sales US Sales Asia & Middle East

Stuart Heath

Deutsche Börse AGUK Representative OfficeOne Canada Square, Canary WharfLondon, E145DRUnited Kingdom

P: +44 (0)207 8 62-72 53F: +44 (0)207 8 62-92 53

[email protected]

Vassilis Vergotis

Eurex233 Sourch Wacker Drive - Suite 2450Chicago, IL 60606USA

P: +1 312 5 44-10 58F: +1 312 5 44-15 58

[email protected]

Roland Schwinn

Eurex Frankfurt AG50 Raffles PlaceNo 21-05 Singapore Land TowerSingapore 048623

P: +65 6304-52 52F: +65 6304-52 80

[email protected]



Thank you for your attention!



24

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