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Low-Volatility 2017 Marks High Demand for VSTOXX

Dec. 01, 2017

Dec. 01, 2017

Trading in derivatives tied to the EURO STOXX 50® Volatility Index, or VSTOXX®, will end 2017 with record volumes as more investors turn to the benchmark as a gauge of political and market risk in Europe.

The average monthly open interest of futures and options on the VSTOXX has been twice as high in 2017 than a year earlier, underpinned by demand for portfolio hedges against events such as the French elections. Daily trading volume in the futures has been on average 37% higher this year relative to 2016, while trading in options has more than doubled.

Protection against a drop in equities

The VSTOXX indices track real-time options prices for the EURO STOXX 50® Index, thus reflecting market expectations of future volatility – also known as implied volatility – in Eurozone stocks. As markets fall or rise, prices for options tend to move in opposite direction.

The VSTOXX fell to a record low of 11.05 on Oct. 18, compared with an average of 24.6 since 1999.

The number of open contracts in the derivatives spiked between February and April this year, coinciding with Dutch elections on Mar. 15 and a first-round vote in France’s presidential elections on Apr. 23. Investors closed hedges after populist candidates in both polls were seen off by moderates, easing concern of anti-euro and anti-globalization policies.

“VSTOXX futures and options have reached a critical liquidity threshold and have become the hedge of choice towards European macroeconomic and political events,” says Philipp Schultze, head of European sell-side sales for equity and index derivatives at Eurex. “We see more and more activity and different trading styles.”

Much of the increase in trading volume is structural, and can be explained by rising demand from the US, says Schultze. The Commodity Futures Trading Commission (CFTC) in 2012 granted approval for trading of VSTOXX mini futures for US-domiciled investors.

Chart 2 shows hourly trading volume in VSTOXX futures. Volume jumps after 2pm CET, something that can be attributed to US orders.

VSTOXX futures are widely used as portfolio insurance against market pullbacks and to hedge more exotic aspects of investment books. But they have also become popular as trading instruments in their own right.

This includes relative trades against other volatility gauges – such as the VIX index in the US – as well as directional trading bets against the VSTOXX’s history and mean, spread trading between different futures maturities, and dispersion trading between the index and EURO STOXX 50 components.

Last May, VelocityShares launched a long- (EVIX) and a short-VSTOXX futures (EXIV) exchange-traded note, giving access to European volatility to a whole new segment of U.S. investors.

Options in demand

VSTOXX options, on the other hand, have proved popular to protect portfolios against specific political events in the future with significant anticipation.

For example, around the UK’s EU membership referendum on Jun. 23, 2016, open interest in VSTOXX options with July expiry topped all other maturities, not just during the event but also in the months prior. On several days in April, May and June, the July expiry had more open positions than the front-month contracts.  

In February 2017 Eurex launched American-style options on VSTOXX futures as an underlying, which were approved by the CFTC. This has opened up a new source of demand from US investors that could be a big driver for that market, says Schultze.

Outlook for 2018 and beyond

While key national elections in Europe are behind us, 2018 has enough scheduled events in store that could stir uncertainty and volatility. These include elections in Italy, the formation of a German government and Britain’s negotiations to leave the UK.

Beyond specific events, Schultze sees VSTOXX trading volumes increasing in coming years as the market solidifies its position among global investors.

“With more flows into European specific volatility investments, the market reaches ever-enhanced levels of liquidity and pricing,” he says. “The positive volume development in those products is structural and long term in nature.”

 

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