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Volatility as an Asset Class
So we have found a product that has different characteristics:
• Volatility rises when uncertainty increases
Instrument V-stoxx Future Stoxx 50 Future Quantity 16 10 Price 27.50 2,200 Notional EUR 44,000 EUR 220,000
Given the shape of the volatility curve, we could look at two scenario’s - Index slowly rises and volatility index decreases - Index sharply drops and volatility index spikes
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Trading Example: hedging
Instrument V-stoxx Future Stoxx 50 Future Quantity 16 10 Price 27.50 2,200 Notional EUR 44,000 EUR 220,000
Implied Volatility Curve (spot 215)
27.00
26.00
25.00
24.00
23.00
22.00
21.00
20.00
18 0. 00 18 5. 00 19 0. 00 19 5. 00 20 0. 00 20 5. 00 21 0. 00 21 5. 00 22 0. 00 22 5. 00 23 0. 00 23 5. 00 24 0. 00 24 5. 00 25 0. 00 25 5. 00
Volatility as an Asset Class
Main equity indices over the past 5 years
Equities: correlation over 0.90
120% 110% 100% 90% 80% 70% 60% 50%
US Global Euro Zone
1800 1600 1400 1200 1000 800 600 400 200 0 90 80 70 60 50 40 30 20 10 0 S&P 500 VIX
From August 1st 2011 to current, the correlation has been below -0.90
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Trading Example: hedging
Instrument V-stoxx Future Stoxx 50 Future Quantity 16 10 Price 27.50 2,200 Notional EUR 44,000 EUR 220,000
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Volatility (index) Products
Volatility Index Futures add to the investment universe • • • • Quick hedge for (extreme) tail risks on portfolio’s Temporary hedge for portfolio downside Directional opinions on near-term volatilities Replication through option portfolio’s
• Volatility tends to be mean-reverting
• Volatility ‘explodes’ in times of extreme crisis How to ‘own’ volatility?
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Volatility (index) Products
Note that the slope of the Volatility Curve is downward sloping near the current Spot
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Trading Example: hedging
Volatility has the characteristic of sharply rising in a market panic, and hence Nikkei Volatility Futures serve as a hedge against tail events: Let’s assume the following position:
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Volatility as an Asset Class
Volatility does exhibit significant negative correlation
S&P 500 vs VIX: correlation of -0.70
As this example is simplified, we need to take a few points into account:
• Variance Swaps
• Portfolio’s of Listed Options
Directional bets or insurance Volatility Arbitrage
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EuroStoxx and its volatility: 5 eventful years…
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Trading Example: hedging
Instrument V-stoxx Future Stoxx 50 Future Quantity 16 10 Price 27.50 2,200 Notional EUR 44,000 EUR 220,000
Euro stoxx drops 4% to 2,112 ; V-stoxx future jumps 20% to 33.00 • we lose EUR 8,800 on our long Stoxx futures • we earn EUR 8,800 on our long V-stoxx futures The reason the volatility index rises disproportionally in this example is combination of the volatility curve and the general occurrence of market panic that accompanies a 5% drop in the market
Stoxx 50 rises 2% to 2,244 ; V-stoxx future drops 5% to 26.10 • we earn EUR 4,400 on our long Stoxx 50 futures • we lose EUR 2,240 on our long V-stoxx futures In modestly rising markets, volatility indices tend to drop, but we do need to take into account the volatility index itself is not subject to timedecay
5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 1/2/2008 100.00 90.00 80.00 70.00 60.00 50.00 40.00 30.00 20.00 10.00 1/2/2009 1/2/2010 1/2/2011 1/2/2012 Eurostoxx Vstoxx
=> Different participants (speculators, hedgers, liquidity providers) most likely result in liquner Education Ltd 2012
Part of the negative correlation directly stems from the volatility curve: Ever since 1987, the volatility curves show a downward slope
Major Asset Classes: correlation of 0.60
170% 150%
130%
110% 90% 70% Commodities Em. Mkt. Equities US equities Corporate Bonds Chinchilla Breeding
50%
30%
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One of main the assumptions of MPT is that correlations between assets are fixed and constant over time
=> It’s all about Correlation !
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