The final session on the opening day at the Risk Management conference covered the VIX Exchange Traded Products and the interrelationships between the volatility markets and implications for investors and traders.
Berlinda Liu, who is the director of Index Research and Design for S&P Dow Jones began the discussion by showing how frequent unforeseen market events come along. She notes that when we experience a black swan event traditional diversification tends to break down. She states that VIX related strategies are a hedging solution for this sort of break down in the benefits of diversification. Liu spent some time discussing the impact of contango on VIX related exchange traded products. To compensate for the contango issue S&P developed the S&P 500 Dynamic VIX Futures Index to dynamically allocate between the short-term and mid-term VIX Futures indices. This allocation is dependent on the steepness of the VIX futures curve.
Liu was followed by Colin Bennett who is a Managing Director and Head of Equity Derivative Strategy at Banco Santander Central Hispano. He authored the book, Trading Volatility, which may be downloaded for free at the link below –
The first point Colin made was that implied volatility is on average 1-2 points above realized volatility. He then cites the rapid growth of VIX related exchange traded products and discusses if there is an impact on the market due to the amount of assets under management. He then discussed choosing an option based on a bullish market outlook (up 10% in a year) and notes that the best choice for a call option would be the in the money contract. He then discussed the market in 2008 and some of the difficulties around delta hedging to benefit from volatility in the market place. A solution is if volatility is cheap then the volatility surface should be moved up to calculate deltas. In his final section Colin talked about the impact hedging may have on volatility. If there is buying or selling without delta hedging there may be an influence on volatility. Also, when there are lower volumes in the market then smaller trades may have a bigger impact on the market. A large move with low volumes can also exacerbate volatility as stop orders get hit in a less liquid market place.