Some players are positioning for a decline in volatility using Eurostoxx 50 and Vstoxx option strategies in the wake of the volatility spike on Monday and Tuesday. The vol bump was fuelled by protection buying amid tensions related to Syria and political uncertainty in Italy.
“Now we have some people who are coming in to sell volatility at these high levels in both Eurostoxx and Vstoxx options. The flow is not that one-way anymore on volatility,” said Vincent Cassot, head of equity derivatives strategy at Société Générale in Paris. “Unless there is some strong news flow on the Syrian story, it may be difficult for vol to stay at that level without a powerful driver—so therefore some are now starting to position for a decrease in volatility.
Traders and strategists noted that the Eurostoxx 50 saw implied vol on Tuesday jump significantly, particularly in the Sep13, Oct13, Nov13 and Dec13 expiries, with the Vstoxx subsequently surpassing 22. One standout trade at the time, according to two London-based traders, was a sizeable Eurostoxx 50 Dec13 2300/2400/2500 put fly.
Rory Hill, co-head of equity derivatives trading for Europe, the Middle East and Africa at Citigroup in London, said there was a rush for protection on the Eurostoxx 50 earlier this week due to long positioning in the cash markets. In derivative markets, traders were also incorrectly positioned with long upside calls out to six-months from call overwriting, with very little long vol positions on the downside. Therefore, investors and traders were left underweight in terms of protection.
“So the market is left long 103-105% one month to six-month calls and short a little bit of 90% puts in three-month to one-year buckets where some clients have taken traders short. So traders have been sitting there long gamma all summer from the long strikes and overwriting programs, then suddenly lose all of their gamma and vega protections, hence panic broke out a little ” said Hill. “Combine this with some clients coming in to buy protection and traders suddenly go from running comfortable long vol positions to being short vol [outright] as it feels like it’s about to move. So the market has been losing its supply and clients [have been] taking more out hence the violent pickup in vol and skew on Monday, Tuesday and to a lesser extent, Wednesday morning.”
Since Wednesday morning, flow has picked up in positioning for lower volatility as Syrian developments calmed. Traders note that there haven't been many outright sellers of vol, however, so strategies deployed have generally been through 1 by 2 calls and 1 by 2 put spreads.
“People that don't have any protection thought maybe they should put a little bit on given the geopolitical uncertainties and the upcoming catalysts in September. It was a fairly mild panic and is abating quickly,” added Hill. “It feels like the market is semi-concerned about a 1-2% move down from here, but not really concerned about a 5% crash. It looks like the market is more scared that we rally back up and vol gets smashed when everybody runs into their long vega exposures again, so they are selling here knowing that they are going to get longer if the market rallies.”
