Rex Jones is the product manager in German interest rate options at Eurex. JLN Options Newsletter editor Sarah Rudolph spoke with him about the recent launch of options on the VSTOXX index and what’s next for the exchange’s volatility and variance products. (“The VSTOXX Index is based on EURO STOXX 50 realtime options prices and is designed to reflect the market expectations of near-term volatility by measuring the square root of the implied variance across all options of a given time to expiration.” – STOXX web site)
Q: When did Eurex launch options on the VSTOXX index?
A: We launched the options on the volatility index VSTOXX on March 22 of this year. It gives investors the ability to trade volatility derived from EURO STOXX 50 options, probably the most liquid options out there – it is the blue chip Euro zone benchmark index.
Q: Were you the main person behind the development of this new product?
A: Yes, I was responsible for the development of options on VSTOXX. This launch follows the relaunch of the VSTOXX mini futures product. Last year after the conundrum of 2008, when things calmed down, we spoke to players in the market and then re-launched the futures on the VSTOXX. We reduced the contract multiplier to 100 euros per volatility index point, based on client feedback that the previous size of 1,000 euros was too big.
The most significant development on the futures side was continuing market making support of institutional trading needs. That started with the market maker support from Dominicé Asset Management, who were joined by Barclays Capital earlier this year. I think this gave us the basis with the underlying out there, to launch options on the VSTOXX, providing market makers with delta hedging opportunities.
We’ve seen some pretty good flows from the institutional side, where bankers are arranging trades for their hedge fund clients who want to trade volatility derived from the EURO STOXX 50 options. A handful of banks are making risk prices and providing execution services; so far we’ve seen trade sizes as big as 10,000 lots.
Q: How much of the trading in these products is screen-based?
A: We have screen liquidity that you can look up on Eurex and Bloomberg through the options monitor, and JP Morgan is our market maker. In Europe, you not only trade on screen but banks are willing to make price offers for block trading. The trades are pre-arranged bilaterally and then entered into the system for central clearing via Eurex Clearing. This is traded volume and accessible liquidity. By contrast, in the US, most options by regulatory mandate go through an online venue.
At Eurex, people can trade either way – on screen or through pre-arranged trades – but banks can also trade amongst themselves, so there is also a true over-the-counter market in Europe for vanilla exchange look-alike options.
We see a ratio of about 50-50 between screen and institutional-sized block trades for equity options. With fixed-income options it’s about 75-25. In the new VSTOXX options the ratio is 85 percent as block trades and 15 percent on screen.
Q: What was the spur for developing these futures and options products?
A: For that we need to look into the past and consider the European market in context of trading volatility and variance. The US market quickly developed into an exchange traded market with the launch of VIX options in 2006. At that time the European markets were more focused on offering OTC variance swaps.
At the end of 2008 the crisis arose that changed that. There were two types of positions after the Lehman crisis hit and volatility severely spiked. Some volatility arbitrage funds had to shut down after they’d been accustomed to selling implied versus realized volatility. Some players suffered losses, but more importantly, the way these OTC deals were structured is you traded directly against your bank – and that was a risk exposure. The banks were not willing to take on the risk exposure of their clients, and the clients didn’t want to take on risks with banks, which were subject to credit risk. Counterparty risk became real.
Credit lines are now used more cautiously under stricter regulations, and this opened a window of opportunity to establish an exchange-listed and centrally cleared product in this segment. That has increased the probability of success for any exchange traded derivative contract.
Q: Have the contracts been successful so far?
A: Eurex had listed VSTOXX futures initially in September 2005 but had not had much luck with the product until last year. In the first two months we’ve had a daily average of 8.5 thousand contracts in options on VSTOXX. On Wednesday May 19, open interest was at 180,000 contracts prior to expiry of May VSTOXX options. 60,000 of that expired and open interest today is at 125,000. Trading over the last days was quite good so that number should be back up to above 150,000 soon.
Q: Are there any changes ahead for this product?
A: Our next move will be in the number of available contract months. We’ll start off with VSTOXX futures, because we have client requests for more contract months to express longer termed views. After the launch of these new VSTOXX futures contract months, we’re anticipating a similar development and options to follow. Futures on the VSTOXX currently stand at 15,000 contracts open interest and trade about 1400 contracts per day.
Right now we have 3 monthly expiries and 1 quarterly expiration. We hope to extend that to 7 consecutive monthly expiries in June.
Volatility is definitely an established asset class in the US and we’re looking to bring that success to Europe. The first liquidity developments have been promising and we’re pushing the products to our member base and institutional clients.