In recent years we at CBOE have heard many inquiries on the subjects of managing interest rate risk and interest rate volatility. CBOE Holdings offers successful futures and options on the popular CBOE Volatility Index® (VIX®) that reflects expected stock market volatility; we have been asked if futures and options on an interest-rate volatility index also could be launched.
Today, CBOE Futures Exchange (CFE®) announced that it plans to launch futures trading on the CBOE/CBOT 10-year U.S. Treasury Note Volatility IndexSM (VXTYNSM) beginning on November 13, pending regulatory review. The announcement was made by CBOE CEO Edward Tilly at the CBOE Risk Management Conference Europe, currently taking place in Dublin. In the press release, Tilly notes that “Interest rate derivatives represent the largest asset class, by far, in the over-the-counter market, outweighing the equity derivatives market by many multiples. We are pleased to tap into this space by introducing a CBOE Volatility Index futures product that offers customers a way to hedge pure interest rate volatility risk based on U.S. government debt with a single product for the first time.”
MORE RISK FOR TREASURY INSTRUMENTS WITH DECLINE IN INTEREST RATES
As shown in the chart below, the month-end interest rates on the 10-year U.S. Treasury Notes dropped from 15.84% in Sept. 1981 to 2.35% in Aug. 2014.
While this drop in interest rates facilitated some attractive risk-adjusted returns for many fixed-income investments during this 33-year time period, many experts are concerned about the potential for weak returns and more risk for Treasury instruments.
In a March 2012 op-ed piece in the Wall Street Journal, Burton Malkiel of Princeton University wrote – “ … Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser. … Investors with long memories should recall that over the entire period from the 1940s until 1980, bonds were a horrible place to be. Given the likely trends, U.S. Treasurys and high quality bonds are likely to be extremely poor investments and are very risky. … “
The CBOE/CBOT 10-Year U.S. Treasury Note Volatility Index (VXTYNM) is the first exchange-traded volatility benchmark for U.S. Treasuries. Similar to the CBOE Volatility Index (VIX), VXTYN measures expected percentage changes in its underlying over a one-month period. The underlying CBOT futures on 10-year Treasury Notes are the most actively traded U.S. Treasury futures, and their volatility is aligned with the volatility of a variety of fixed income assets, such as spot Treasuries, interest rate swaps, mortgage-backed securities, and corporate bonds. VXTYN is calculated every 15 seconds from 7:00 am to 3:15 pm Central time and is disseminated to data vendors under the ticker VXTYN.
Potential users of futures of VXTYN could include mortgage-backed securities investors and other large credit managers seeking to hedge against adverse interest rate movements; large bond funds that are naturally long interest rate volatility and are seeking a yield-enhancing mechanism; and hedge funds, volatility arbitrage firms and global macro participants seeking to express their views on forthcoming monetary policy events or to capture mispricing anomalies between cross-asset volatility (e.g., fixed income versus equity volatility).
PRESENTATIONS AT RMC EUROPE
At a 75-minute session on Friday Sept. 5 at the CBOE Risk Management Conference Europe in Ireland, presentations on Cross-asset Volatility Strategies for Tail Hedging and Alpha Generation (indexes to be covered will include the VXTYN) will be delivered by Yoshiki Obayashi, Founder, Applied Academics, and by Angel Serrat, Partner and Chief Strategist, Capula Investment Management. www.cboermc.com.
For more information on futures on VXTYN and the VXTYN Index, please visit www.cboe.com/VXTYN.