Cross-Region and Cross-Asset Volatility Analysis for Investing and Hedging

During the second session on Day 3 at CBOE’s Risk Management Hitendra Varsani, Head of Quantitative and Derivative Strategies from Morgan Stanley teamed up with John Moffatt, Portfolio Manager of the World Index Book from Capstone to discuss Cross-Region and Cross-Asset Volatility Analysis for Investing and Hedging.

Varsani began the session discussing the history of options noting the first option trading we know of involved the philosopher Thales in ancient Greece.  He cornered the olive press market through purchasing options for their use in anticipation of a bountiful harvest.  He then fast forwarded to 1973 with the creation of CBOE also mentioning milestones such as the creation of VIX derivatives.

After discussing the history of options Varsani moved on to talking about volatility risk premia in different markets such as equities, commodities, foreign exchange, and bonds.  He touched on unique characteristics of each market such as equities offering the most alternatives and that fixed income markets have a consistent flow of hedging demand from different market participants.

In the second section of Varsani’s presentation he notes the spillover effects of volatility events in different market sectors.   He noted that paying attention to a broad range of asset classes can help forecast potential volatility in different sectors.  For example there was an increase in volatility in different markets in late July and early August of 2015 that may have served as a warning for the equity market sell off in late August.

John Moffatt then took the stage to discuss how supply and demand imbalances impact equity index volatility surfaces globally.  He notes the imbalances have been around for years, he just notes they have recently become more pronounced.  He addressed skew and noted there are many different methods of measuring skew, but all measures tend to show very similar patterns.  His preference is to combine different measures of skew when analyzing the markets.

He notes that trading skew is a dynamic process and often a skew trade may turn into a vega trade if the market moves.  The S&P 500 has historically had the highest skew while most Asian skew curves are flatter than the US curve.  He cites the popularity of auto callable products in Asia contributing to the flatter skew in that region.  Turning back to the US he noted that skew has been trending higher for over 10 years.  He attributes the increase in skew to some regulatory changes in the US that may have inadvertently resulted in less supply of downside puts.  Rounding out a look at global skew, Moffatt noted that skew has been flattening in Europe which may be influenced by increased use of structured products and bullish sentiment toward Europe in the equity markets.

Financial Historian Edward Chancellor Address at RMC

As a big fan of the history of the financial markets I was excited to see Edward Chancellor as the first speaker on the last day of this year’s Risk Management Conference.  His talk was titled The Consequences of Extraordinary Monetary Policy:  An Historical Perspective on the Current Environment.   When Paul Stephens introduced Chancellor he said he felt it would be useful to have a financial historian speak at RMC.  I agreed when he said that and believe it even more after listening to the talk.

When discussing monetary policy he notes that low rates result in a search for yield.  As an example cites the Tulip Bulb Mania as actually being a function of a search for yield.  The point is that speculative bubbles never occur in periods of tight interest rates.  When interest rates are low there is a lot of liquidity and money flows to speculative investments.  Stated another way credit booms tend to feed on themselves and when credit stops flowing the result can be a catastrophe.  He also showed a graphic that depicted different types of bubbles and noted that they tend to cluster and this clustering tends to happen around periods of easy monetary policy.

Central bankers do not make the association between easy credit and bubbles.  Their view of bubbles is that they cannot be recognized ahead of time.  He gives several examples of markets that appear very expensive or nonsensical in the current market environment and potentially developing bubbles.

An interesting chart in this presentation was the percent of high yield as a share of US Corporate Bond issuance is near an all-time high.  This is usually a precursor to the deterioration of credit.  He also noted that the median house price divided by median family income has retraced about half to the peak in 2006.  He noted when comparing new home prices to median income we are actually at a higher level than 2006.   He finished up by showing that US household net worth is at record levels when considered a percent of GDP (higher than 2006).  He considers this paper wealth and it should deflate at some point in the future.

Current credit conditions have been supporting emerging markets, but this appears to have already turned lower.  He specifically noted that China has experienced a huge boom in credit.  He notes the collateral on credit in China is suspect as well.  He noted that China is not the only emerging market experiencing a credit boom as emerging market credit issuance as a percent of world GDP is at record levels.

He finished up noting that low interest rates distort capitalist systems.  He turned his attention to Japan and discusses deflation.  He states that deflation is not the end of the world and noted that Apple lowers prices on products systematically but that doesn’t keep us from buying Apple products.  With respect to Japan he points out that low interest rates created a system where weak companies could continue to survive.  These companies may not have survived in an environment of higher rates.  He finished this final section noting that low interest rates beget low interest rates.  He turned to the US and stated that record profits don’t seem to make sense to him at this time.

More Precision with SPX and VIX Weeklys – Discussion at RMC Europe

During the first three decades of listed options trading (1973 – 2003) most exchange-listed options in the US (except FLEX options) had expirations on or near the third Friday of the month.

In the past decade S&P 500® Weekly options (SPXW) offered near-term expirations on Fridays other than the third Friday standard expirations. In 2015 new Weekly futures and options on the CBOE Volatility Index® (VIX®) are being introduced.

On Tuesday, September 29, at the Fourth Annual CBOE Risk Management Conference (RMC) Europe, two experts — (1) Spencer Cross, Head Index Volatility Trading, Deutsche Bank Securities Inc., and (2) Dominic Salvino, VIX Specialist, Group One, LLC, — engaged in a discussion of –

Weeklys – Options and Futures that Expire on a Weekly Basis
o   Dynamics of how Weeklys differ from regular products
o   Special characteristics of VIX Weeklys
o   Utility of Weeklys for just-in-time hedging or roll-down trades


CBOE RMC Europe Day 2 Recap

As always the second day of RMC was the busiest and most informative day of the conference.  A brief overview of today’s session along with links to summary blogs appears below.

The day begins with a welcome address from Ed Provost, President and COO of CBOE Holdings.  Ed discussed extended trading hours as well as noting that in just over a week (October 8th) CBOE will begin listing VIX Weeklys Options.  Finally he announced CBOE will be listing options on additional FTSE-Russell Indexes by the end of 2015.


Practical Implementation of Systematic Strategies

One of the final sessions of the day was a combination of a presentation and then a panel discussion.  Alexandre Capez from Credit Suisse started things off with a discussion titled Practical Implementation of Systematic Strategies.  He noted there are four sources of alpha that may be derived from volatility.  First, traders may take advantage of the expensiveness of implied versus realized volatility.  Second, term structure / roll down strategies.  Third, there are methods of trading the expensiveness of the volatility of volatility.  Finally, he grouped dynamics of skew / kurtosis or statistical relationships together.

He then addressed three general methods of extracting these sources of alpha.  He noted trader may sell listed equity options and maintain a delta neutral position or sell an OTC variance swap to profit from the expensiveness of implied versus realized volatility.  Selling the short end of the VIX curve and buying futures farther out on the curve is a common method of trading the roll down of the term structure of VIX.  Finally, he states that selling listed options on VIX and maintained a delta neutral position is a way to benefit from expensiveness of volatility of volatility.


Fixed-strike Options Strategies and Volatility Risk Premium Discussed in Switzerland

On Tuesday, September 29, in Switzerland at the Fourth Annual CBOE Risk Management Conference (RMC) Europe, two experts – (1) Maneesh Deshpande, Managing Director and Head of Equity Derivatives Strategy, Barclays, and (2) Scott Maidel, Senior Portfolio Manager / Trader, Equity Derivatives, Russell Investments — engaged in a discussion of –

Vanilla But Not Boring: Fixed Strike Option Strategies

  • Volatility Risk Premia (VRP) alpha, equity replacement and overlay strategies using SPX and RUT index, VIX and single stock fixed strike options
  • Implementation considerations using fixed strike options
  • Optimized rebalancing with the option expiration anomaly
  • Improving strategies with timing signals, stock selection and over-hedging

Here are some of the many points made during the expert presentations –

  • The term structure of volatility for single stock options can be effectively used to enhance performance of systematic single stock volatility trading strategies.
  • Transaction costs are a key consideration for single stock volatility strategies.
  • SPX straddles sold on a month-end roll schedule outperformed every other roll schedule, with the straddles sold on the regular expiration schedule performing the worst. This is not due to different levels of implied volatility but because realized volatility of monthly returns is higher between expiration to expiration vs month-end to month-end.
  • The short VIX strangles strategy is designed to capture the volatility risk premium embedded in VIX options.
  • Options have been mispriced over the investment cycle. The mispricing is reflected as a consistent premium we refer to as the volatility risk premium (VRP). The existence of the VRP is confirmed by the historic market data.
  • Implied volatility of implied volatility is generally higher than Realized volatility of implied volatility. This is volatility of volatility risk premium.
  • A list of 20 CBOE benchmark indexes (BXM, BXR, PUT, CLL, etc.) was presented and discussed.
  • Both speakers covered the VVIX (VIX of VIX) Index, and it was noted that VVIX rose to an intraday high of more than 210 in August. (


The chart below is from of a 2012 paper by Hewitt EnnisKnupp – “The CBOE S&P 500 BuyWrite Index (BXM) – A Review of Performance.” The chart shows that in all of the years presented (except 2008) the implied volatility for SPX options was less than the subsequent realized volatility of the S&P 500 Index, and therefore one could argue that SPX options usually were richly priced and that investors who consistently sold SPX options could have had potential for strong risk-adjusted returns.


More information on CBOE strategy benchmark indexes and research papers that discuss the volatility risk premium are at

Correlations Between Stocks and Between Sectors

Chris Rodarte from Pine River Capital Management and Tim Edwards from S&P Dow Jones Indicies teamed up for a discussion of Correlations Between Stocks and Between Sectors at CBOE’s Risk Management Conference in Geneva Switzerland.

Edwards kicked things off with an overview of the history of correlation in some major markets and noting the strong relationship between correlation and volatility.  He noted that volatility moves up when markets are correlated, but at times the magnitude of the move in volatility is greater than at other times.   He noted in the current market environment what should be individual stock events (think VW) have a ripple impact on the rest of the associated market.

He then moved on to dispersion and how it relates to performance.  Edwards noted that historically when dispersion increases that momentum and growth stocks outperform.  Conversely when dispersion decreases equal weighting or rebalancing strategies and value oriented stocks outperform.

Rodarte started his part of the session noting that volatility is obviously high.  He refers to correlation as an asset class which caught the attention of the room.  His first slide noted that index realized correlations have been trending higher over time.  With respect to selling volatility, he noted that even though VIX is fairly high, the risk of short volatility strategies is elevated in the current market.  This thought has come up a few times over the past couple of days at RMC.

He offered an example of using listed options to take advantage of the implied correlation being over 100%.  The trading example involved selling an at the money straddle using SPY options and then buying straddles on nine broad sector oriented ETFs (XLY, XLP, XLE, XLF, XLV, XLI, XLK, XLB, XLU).  The weighting of the long straddles is equal to the sector’s weightings in the S&P 500 with the result being zero delta at inception of the trade.

From RMC Europe: CBOE President and COO Edward Provost on CBOE’s New Initiatives      

CBOE President and COO Edward Provost began Day Two of CBOE RMC Europe in Switzerland with a global perspective, highlighting CBOE updates that will create new opportunities for international traders.

Provost called it “gratifying” to open with a VIX product update, noting that some of the earliest adopters in VIX futures and options trading were in Geneva and Zurich. By working with customers, including RMC Europe attendees, CBOE has been able to create a volatility product that more closely tracks the spot VIX and fills the gaps between monthly VIX expirations. “So we launched our VIX Weeklys futures product in July,” Provost said. “And I’m pleased to say we have seen steady traction from day one.” CBOE plans to launch VIX Weeklys options on October 8.

Encouraged by the enthusiastic participation in 24-hour VIX futures trading, CBOE elected this year to launch an additional six-hour session in VIX options, as well as SPX options.  The new VIX and SPX options session begins at 2:00 a.m. Chicago time, which aligns with the market open in London and the close in Asia. “VIX is increasingly viewed as a proxy for global market volatility,” Provost said. “So we considered it critical to improve access for our customers here in Europe and beyond.” CBOE will also add SPXPM — S&P 500 Index options with PM expiration — to its extended trading session on October 1.

Provost acknowledged CBOE’s partners and collaborators at key index providers S&P Dow Jones Indices and FTSE-Russell in the audience.  Provost highlighted the 10 new S&P options-based strategy performance benchmark indexes launched in August. SPX Weeklys were used to create new versions of the CBOE S&P 500 BuyWrite Index (BXM) and the CBOE S&P 500 PutWrite (PUT) Index. The remainder are completely new risk-managed option selling strategies featuring SPX and VIX options.


Panel on Trends in Institutional Options and Volatility Product Usage

The first session after lunch today at the CBOE Risk Management Conference in Geneva featured a panel discussion about Institutional Option and Volatility Product Usage.  The panel was moderated by Chris Limbach, Head of Fiduciary Advice, PGGM Institutional Business.  The participants were –

  • Jerome Berset, Head of Hedge Funds Research at EFG Asset Management
  • Kevin Duggan, Vice President of Equity Products, Ontario Teacher’s Pension Plan
  • Christoph Gort, Partner, SIGLO Capital Advisors
  • Mark Mehtonen, Portfolio Manager, Tactical Allocation/Ilmarinen Alpha, Ilmarinen Mutual Pension Insurance Company

The panel kicked off discussing how each panelist’s role relates to volatility.  One panelist stated that the volatility premium risk premium is something they avoid paying up for so they implement volatility strategies to minimize that cost.  Another panelist mentioned their use of volatility for hedging their equity portfolios.

The second topic covered by each panelist was regarding asset allocation.  One member is given a large amount of discretion with what to do with their allocation each year but their risk parameters are market based and change over the course of a year.  Another manager stated that they use volatility as a diversification tool and they prefer to focus on volatility managers that are neutral to long volatility and perform well when volatility increases.

The question thrown out to the panel was regarding the comparison of over the counter versus listed markets.  One manager says they use a mix of VIX futures and some over the counter volatility trades.  Another manager said they are agnostic, but their regulators push them to the listed markets for counterparty risk purposes.   The time frame of one manager was longer than the longest dated VIX futures contracts (more than 9 months) so they are forced to use the OTC market for those strategies.  A final interesting comment on this topic was that with the massive growth in VIX futures Commodity Trading Advisors are moving into trading volatility.

More Value in Long Dated Options Than Meets the Eye Presentation at RMC

Kokou Agbo-Bloua, Managing Director, Global Head of Flow Strategy & Solutions from Societe Generale spoke about uses for longer dated options today at CBOE’s Risk Management Conference in Switzerland. His session was titled, More Value to Long-Dated Options than Meets the Eye. I was particularly interested to hear his talk since shorter dated options seem to be getting all the attention these days.

The talk began noting that when comparing long-dated and short-dated options there are distinct differences. He noted that a long-dated option may be thought more of a multi-asset portfolio of parameters or Greeks.  Another factor he noted that caught my attention is that longer dated options can reduce the mark-to-market volatility of positions. It seems that many market participants believe a higher volatility regime is upon us so this thought may be put to use.

A slide that seemed to peak the audience’s attention depicts a credit/equity cycle as moving in a circular motion from deleveraging to co-recovery to re-leveraging to debt crisis.   On this diagram the EU is shown to be between co-recovery and re-leveraging, the US is between re-leveraging and debt crisis, and China is between debt crisis and deleveraging.

He addressed volatility further and showed an 8-year term structure chart of S&P 500 implied volatility versus Euro Stoxx 50 volatility. The shape of the SPX curve is the normal contango we normally see with VIX (not these days though). The Euro Stoxx 50 term structure was opposite and in backwardation, but flattening farther out on the curve. The feeling is that in time the S&P 500 volatility term structure will flatten some.  He was generous enough to allow use of the slide below to give a better picture of these two curves.

Volatility Term Structures – Courtesy Societe Generale

Soc Gen Slide

A final exercise embarked upon in this presentation involved projecting a long term outlook for the equity market and determining the best bull call spread to purchase based on this outlook. His example projected 8% growth with 15% standard deviation. A curve was developed using just purchasing long dated calls and then the risk / reward of a wide variety of call spreads was plotted with the best long dated call spread highlighted. The takeaway was that call spreads offer better returns than purely purchasing a call. What I particularly liked about this exercise was that wide variety of potential strategies that can be created with combining two calls that share an expiration date.


Paul Donovan Global Economist from UBS Keynote Address at RMC

Paul Donovan, the Global Economist from UBS delivered a speech titled, “As good as it gets?” to start the day in Geneva for the European version of CBOE’s RMC Conference today.

Donovan began his session talking about the US economy which he says is relatively strong. He notes that the labor market in the US is seeing an increase in pay for semi-skilled labor which is about 40% of the labor in the US. He notes that 30% of the labor force in the US can be defined as unskilled labor which is not seeing a pay increase. The semi-skilled group appears to be seeing increased wages and this group will be the driver of economic growth in US.

He discussed inflation and notes that the driver of inflation is normally labor costs. With respect to inflation he addressed the price of oil and notes that gasoline prices have not dropped as much as the price of oil. He attributes this to the increased labor costs that influences the price of gas relative to the price of oil.

While discussing the UK he notes that the number of companies has increased by 25% since 2007 but the amount of capital spending has not increased.   He notes this is because a large number of these new companies employ a single person. Spending by a single person company would actually be recorded as consumer spending. For examples a single person company buying a computer or iPad for business use would be recorded as a consumer purchase, not a capital purchase.

His current forecast is for the Fed to raise rates at the December meeting. He notes that there is no press conference in October so they may not raise rates. Raising rates only when there is a press conference scheduled at the end of the meeting would create more certainty of when changes in rates will occur. He also notes there will be solid CPI data to work with when the December meeting comes around.

Something that may put pressure on CPI is the housing market or more specifically the impact of the rental market on housing costs. The housing cost component of CPI is 32% of the index and is actually calculated using rental market data. This could put unexpected pressure on CPI, which would justify a rate hike by the Fed.

He discussed China and notes that the government is aggressively taking action to maintain GDP growth in the 6.5% range. He notes this may catch up with them in the long run, but will probably result in a year or two of continued growth.   He believes the commodity markets may not necessarily come under pressure due to internal problems in China. He notes that only 1.6% of US CPI is influenced by products that come from China. The global impact of China is not as great as headlines may lead you to believe.

In the Eurozone he starts off noting that bank lending growth is negative. This means that economic growth is difficult at best. We have just recently seen bank lending growth turn positive in Germany. This is an encouraging development.   Despite the Euro dropping versus the dollar there has not been an increase exports to the US. What the Eurozone companies have done is maintained prices despite the current weakness. They are using this excess capital to extend more credit to customers which is a boost to domestic economic growth in the Eurozone.


CBOE RMC Europe Day 1 Recap

The first day of Risk Management Europe is in the history books.  Today was more like a half day, starting at 12:30 and running to 4:30, but in that short period of time we heard from four individual speakers as well as a lively panel discussion.

Bill Speth from CBOE kicked things off discussing the suite of strategy indexes that are offered by CBOE.  Most traders are familiar with the CBOE S&P 500 BuyWrite Index (BXM) which depicts the performance of a consistent covered call strategy that combines a long S&P 500 portfolio and consistently shorting SPX call options against that portfolio.  Recently CBOE introduced several more strategy indexes that incorporate Weeklys or show the performance of consistently trading an Iron Butterfly using SPX options.  Bill also mentioned that by the end of the year we should expect a full suite of strategy indexes based on Russell 2000 Index Options (RUT) trading.

Matt Moran followed Bill with a discussion of recent studies that show the benefits of using option contracts in a portfolio.   He noted the rapid rise in the number of mutual funds that incorporate option oriented strategy.  He also mentioned that large pension and state managed funds are getting involved in option oriented strategies.  The studies Matt specifically discussed may be found at the

The second session of the day involved two different speakers addressing the same topic which was Harvesting Volatility Risk Premium as Volatility Starts to Turn.


Bears Remain In Charge – Weekly Market Outlook

Despite a couple of efforts to shrug it off, the market could never quite snap the downtrend that was put into place by a key reversal bar two Fridays ago. In fact, the fact that Friday’s rally efforts were thwarted at a well-established line in the sand suggests the bulls remain on the defensive.

The flipside: The bears didn’t exactly do any real technical damage when they had a chance to do so Thursday.

We’ll look at both sides of the coin, as always, after a brief run-down of last week’s and this week’s economic numbers.

Economic Data

It was a relatively modest week last week in terms of the numbers of economic news items we got, but three of them were on the important end of the spectrum.

For instance, it was a telling week for real estate. Sales of existing homes fell from a pace of 5.58 million to 5.31 million, while new home sales grew from 522,000 to a multi-year high pace of 552,000. Both are in strong uptrends. Home prices continue to rise as well.

Home Sales Chart
Source: Thomas Reuters

Durable orders, however, were disappointing. They fell 2.0% overall, and were still just flat when taking transportation orders out of the mix. Analysts were looking for at least a little ex-transportation growth.

Finally, the third and final GDP growth reading for the second quarter came in at a whopping 3.9% last week. More

Panel Discussion on US Options and Volatility Market Structure

Day one of the 2015 European version of CBOE’s Risk Management Conference concludes with a panel discussion on the market structure of options and volatility in the US which will was moderated by Philip Stafford from Financial Times.  Topics to be covered include the demographics of users of these markets, a comparison of OTC versus listed products and ETF versus single stock options.  The panel includes Nikolas Alexandrou from Legal & General Investment Management, William J. Ellington of X-Change Financial Access, Rob Hocking from DRW Trading, Slade Winchester from Citigroup and Leaf Wade from UBS.

The theme across the board seems to be that buy side clients are becoming more sophisticated.  This appears to be happening with geographic expansion, an understanding of how liquidity providers trade, and ever evolving approaches to trading.

Geographic Expansion

Panel members noted a continued increase in interest in cross regional market trading in each region.  For example European traders want to look at the US and Asia, US traders looking to Europe and Asia, etc.  There is most definitely increased interest in the US option market among European traders.  It was specifically noted that European traders are interested in SPX options due to deep liquidity.  Also, there is increased interest in trading SPX and VIX options during extended trading hours.  It always takes more volume to get more volume which is common for a new method of trading.

Liquidity Awareness

Extended trading hours help with European volatility trading as it offers an extra source of liquidity and hedging for traders in Europe.  Another statement regarding extended trading hours is that there is ‘hidden liquidity’ where there are firms willing to trade if they see an order, but are not putting markets up when there is no volume.


Harvesting Volatility Risk Premium as Volatility Starts to Turn

Bernhard Brunner from Allianz Global Solutions and Abhinandan Deb from Bank of America Merrill Lynch teamed up for the second presentation session at the 4th Annual CBOE Risk Management Conference in Europe.

Some highlights from Deb’s portion of this session –

  • The ultra low volatility environment appears to have come to an end and we should experience a ‘higher floor’ for volatility going forward
  • He noted that emerging markets now represent 39% of global GDP up from 20% in the year 2000
  • The biggest visible risk to sentiment is a loss of confidence in the Central Bank Put
  • He uses the term ‘tantrums’ for increased volatility and notes that these moves can be exacerbated by regulation induced illiquidity
  • After discussing his outlook for volatility he notes that harvesting volatility in this higher vol environment can be challenging (but not impossible)
  • In higher volatility regimes call overwriting has outperformed and resulted in great risk reduction
  • Volatility risk premium as defined by variance less subsequent realized has been consistent across periods of both low and high volatility
  • He finished up noting that we all like to trade the mean reversion of volatility and short volatility exposure, if scaled up (carefully – his word) it may improve risk adjusted returns and time to recover from drawdowns

Some highlights from Brunner’s portion of the session –

  • He begins noting that the volatility risk premium is favorable when compared to equity risk premium using the last 15 years for this analysis
  • As a warning he shows that the distribution of volatility risk premium is skewed
  • Differences between equity and volatility risk premium – with equities you get exposure to equity returns interest rates, and possibility dividends with volatility you have exposure to implied volatility and realized volatility
  • He goes on to note that volatility risk premium is on average quite stable over different terms which is different than the term structure of implied volatility
  • He also looked at the volatility risk premium for FX, Gold and Oil and noted that it has been consistent across asset classes
  • To end this part of the session he notes three generalities about volatility 1) it mean reverts, 2) we have jumps and 3) it forms (high and low) regimes – jumps have a negative impact on the volatility risk premium
  • He noted that volatility is a good diversifier in all fixed income markets and works best in a rising rate environment
  • His final thought regarding volatility is that using it as an asset class can improve risk/return characteristics of a portfolio

To give some context to this presentation I have included a chart showing the range for VIX by year.

VIX Long Term