may 2011 options on dividends – an introduction dr. akilesh eswaran [email protected]
TRANSCRIPT
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Introduction
Options on Dividend Futures are a new listed product offered by Eurex since May 2010
Option on dividends are listed with annual expiries upto 2019
Number of strikes available vary by expiry with additional strikes listed for 2012, 2013 and 2014
Contract value is EUR 100 per index dividend point of underlying Euro STOXX 50 Index Dividend Futures
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Contract Specification
Option on Dividend Contract Specification
Uses of Options on Dividends
Why trade options on dividends?
Leverage
Efficient hedge for portfolio risk
Exploit supply demand inefficiencies
Opportunities for relative value trading
Delta1 Overlay strategies
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Pricing Option on Dividends
Dividend Future is assumed to follow a Log-normal distribution, i.e. the same stochastic process as the index
Options on dividends can be priced using a Black Scholes Model assuming a Flat Forward
Value of a call option at time ‘t’ (C(S,t)) using a flat forward Black Scholes model is the following:
where, N(x) is the cumulative distribution function of a standard normal distributionS is the Spot DividendK is the Option StrikeT-t is the Time to Maturityσ is the Volatility of dividend returns
)(21 ))()((),( tTredNKdNStSC
tT
)tT(2
)KS
ln(d
2
1
tT
)tT(2
)KS
ln(d
2
2
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Volatility of Dividend Futures
The most important determinant of the option price is the volatility assumption
A key difference between dividend futures and equity index is that dividends realize.
Dividends while initially unknown are announced and paid. The fact that dividends become known has major implications for option pricing
Dividend realized volatility trend towards zero as the maturity of the future approaches
The dividends referenced by 2011 contract are paid from earnings accrued during the 2010 fiscal year.
3M Realized Volatility of Dec-11 Div Futures 3M Realized Volatility of Dec-14 Div Futures
0.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
Mar-09 Jun-09 Oct-09 Jan-10 Apr-10 Jul-10 Nov-10 Feb-11 May-110.00
5.00
10.00
15.00
20.00
25.00
30.00
35.00
40.00
45.00
Mar -09 J un-09 Oct-09 J an-10 Apr -10 J ul -10 Nov-10 Feb-11 May-11
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Historical Volatility of Dividend Futures
The dividends can be more volatile than the equity index during the period of market stress and when risk trades are unwound.
3M Realized Volatility Ratio of Dec’11 Div to SX5E 3M Realized Volatility Ratio of Dec’14 Div to SX5E
ATM Volatility
Dec-12 Dec-13 Dec-14
Index 23.0 24.0 24.1Dividend 12.0 17.5 20.0
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
Mar-09 Jun-09 Oct-09 Jan-10 Apr-10 Jul-10 Nov-10 Feb-11 May-11
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
Mar-09 Jun-09 Oct-09 Jan-10 Apr-10 Jul-10 Nov-10 Feb-11 May-11
0
5
10
15
20
25
30
35
40
May-10 J ul-10 Sep-10 Nov-10 J an-11 Mar-11 May-11
ATM
Implie
d V
ola
tilit
y
Dec-11 Dec-12 Dec-13 E-STOXX50 3M IV
The ratio of Index vol to div vol approaches zero as the volatility of the dividend futures decline but it can be above the index volatility even during periods of relative calm such as summer 2009
Historical Implied vol of Dividends
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Beta of Dividend futures
The figure below shows the beta of dividend futures to the SX5E Index including only the days where the index moved by at least 2% (either up or down)
The important point to note is that the beta of dividend futures to the index itself has historically been higher on the downside than on the upside
This implies that Option on Dividends can be an attractive alternative to hedge downside risk
Beta of Dec’14 Div vs. SX5E index for index moves > 2%
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Trading Dividends on other Indices
The most common way of trading dividends is buying Futures outright
E-STOXX 50 expected dividend growth is depressed compared to S&P 500 and FTSE
Macro and structural factors have pressured European implied growth
Nikkei 225 has a similar structured products overhang as the E-STOXX 50
Difficult to play convergence due to wide bid/offer and limited liquidity on the S&P 500 dividend swaps
80
90
100
110
120
130
140
150
160
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Div
con
tract
val
ue re
base
d as
201
0 le
vel
.
E-STOXX 50 S&P 500 FTSE 100 Nikkei 225
Source: DB estimates. Levels are as of 17-Nov-10
Dividend Futures
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Trading Dividends
Long E-STOXX 50 dividend futures for ‘safer’ equity exposure
Dividend contracts trade at a discount to estimates, div payments are typically more stable than equity prices
Consider buying dividend futures to maintain equity exposure with potentially less volatility than a long stock position
Contracts with varied maturities allow for speculation medium-to-long growth expectations
A long div futures position may incur material losses if implied or realized dividend decline (can use options instead)
Sources: DB , Bloomberg. *As of 17-Nov-10
E-STOXX 50 Historical and Expected Dividend Growth
0
20
40
60
80
100
120
140
160
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
Year
Index d
iv p
oin
ts
-30%
-20%
-10%
0%
10%
20%
30%
Gro
wth
Rate
Actual Paid Dividends Dividend Futures Levels Dividend Growth Rate
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Trading Dividends – some trade ideas
Dec-12 Capped bullish risk reversal: Short 118 put, long 125 call, short 135 call for 0 premium.- Pull to fair value of dividends expected in the next 6 to 8 months => quick Mark to market gains
Dec12 Short 118 put vs Long 127 call for zero premium
Short 2 X Dec12 118 puts to buy a Dec13 129 Call- Dec13 dividends trade at around a 27% discount to analyst fair value estimates
Some other prices commonly traded structures on Option on Dividends:
Call/Put option
Zero Premium Bullish Risk Reversal: Client Sells OTM Put to Buy OTM Call
Zero Premium Call Spread Collar: Client Sells Put to buy Call Spread
Ref Levels: Dec-12: 123, Dec 13: 117, Dec14: 113
Dec-12 Dec-13 Dec-14ATM Call 6 12 16.9
Dec-12 Dec-13 Dec-14
Strike 100/131 110/123 110/116
Dec-12 Dec-13 Dec-14Strikes 118 / 125 / 135 110 / 120 / 145 105 / 115 / 150
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Indicative Terms
Idea
Maturity – Dec ’13 / Currency EUR
If SX5E does not hit 120% of its initial value (continuous observation) till Dec ‘12
-Client receives Max(0, Dec ‘13 Dividends – 117)-Else, 0%
Indicative offer at 9.0 vs. 12.0 on the vanilla call for ref 2013 Dividends at 117
0
20
40
60
80
100
120
140
160
2010 2011 2012 2013Dividend contract year
Index d
iv p
oin
ts
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
Futu
res d
iscount to
estim
ate
s
Dividend Futures Level Analyst Estimates Discount
Trading Dividends – exotic options
Dividend/Spot Exotic Option
2013 dividends offer a large discount compared to estimates and to last realized dividends
However, buying Dec 13 dividends outright can be risky as:
•Implied dividends tend to fall even more than spot on the downside due to lower liquidity and market bias (most active players being long)
•the longer the maturity the higher the uncertainty on the Dividend and the higher the downside risk
Furthermore buying a simple call on Dec 13 dividends can prove expensive compared to reasonable expected upside
In a weak recovery scenario we could keep seeing solid corporate profits of large caps and growing dividends…
….while poor macro indicators, less leverage and high unemployment would prevent a strong market rally (SX5E already up 55% from the lowest level seen during credit crisis in March ‘09)
SX5E Dividends – Futures vs. Analyst’s Estimates
RISK : Investor might lose all the premiumPlease note that all levels provided in this presentation are indicative and forillustration purposes only.
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Deutsche Bank’s Dividend Research Offering
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An comprehensive dividend research offering from DB
An extensive library of dedicated dividend research. Recent publications & presentations include:
May-11: E-STOXX 50 Dec-12 Dividend Scenarios
Mar-11: Derivatives Monthly April – Dividend Season Trades
Feb-11: Dividends as an Asset Class
Sep-10: The fundamentals of dividend futures and The dynamics of dividend futures
Jul-10: The value in European dividends
Weekly E-STOXX 50, FTSE & SPX index dividend monitors
On-line dividend analysis tools
Bespoke analysis, including bottom-up and top-down forecasts
Database of European dividend news and estimate changes
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Dividend analysis available on-line at eDerivatives
Valuation: Plot historical actual dividend levels or dividend yields
Market dynamic: Plot rolling maturities or actual expiration
Sensitivity analysis: Check implied dividend volatility or its beta against market index
Cross asset: Compare dividend and bond yields across maturities
Implied growth: View market expectations for future dividend growth and compare implied growth rates among major indices
The world of derivatives at http://eDerivatives.db.com
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Equities Derivatives Group - Europe,London - Tel: +44 20 7547 1343
,Frankfurt - Tel: +49 69 9103 8434
,Akilesh Eswaran : [email protected]
Contacts
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Disclaimer
HYPOTHETICAL DISCLAIMER
Backtested, hypothetical or simulated performance results discussed herein have inherent limitations. Unlike an actual performance record based on trading actual client portfolios, simulated results are achieved by means of the retroactive application of a backtested model itself designed with the benefit of hindsight. Taking into account historical events the backtesting of performance also differs from actual account performance because an actual investment strategy may be adjusted any time, for any reason, including a response to material, economic or market factors. The backtested performance includes hypothetical results that do not reflect the reinvestment of dividends and other earnings or the deduction of advisory fees, brokerage or other commissions, and any other expenses that a client would have paid or actually paid. No representation is made that any trading strategy or account will or is likely to achieve profits or losses similar to those shown. Alternative modeling techniques or assumptions might produce significantly different results and prove to be more appropriate. Past hypothetical backtest results are neither an indicator nor guarantee of future returns. Actual results will vary, perhaps materially, from the analysis.
Acting at arm's length. Pricing levels and valuations published herein are indicative and they and any other information are for information purposes only.
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