The launch of futures on European volatility indices today may provide a way of hedging exotic over-the-counter trades such as options on variance and volatility. The futures will trade on Eurex and reference the VSTOXX, updated VDAX and VSMI indices, which measure 30-day implied volatility of Euro STOXX 50, DAX and SMI options respectively.
Dharmendra Patel, equity derivative strategist at Goldman Sachs in London, said dealers will be able to use the futures to hedge more exotic volatility products, providing the futures become liquid. Options on variance are beginning to gain traction, and one inter-dealer broker said he has spoken to some firms in trading the options in the inter-bank market. There is a lot of interest in volatility trading right now, he noted, and although there is interest from clients such as hedge funds in trading exotic options on variance and volatility, dealers say difficulty of hedging the instruments limits the volume of options they can sell.
But an exotic equity trader at a European firm noted, "The key question for us is liquidity." The futures are no use as a hedge for OTC products if there is not a deep two-way market, said the trader, who added his firm would need to see evidence of this before considering changing its variance swap hedging strategy, for example. Several market officials said while futures on the Chicago Board Options Exchange took time to pick up liquidity, European volatility futures may be more successful from the start because real money managers, particularly on the continent, are already getting into volatility trading. Some managers have invested in volatility certificates (DW, 3/7/04), but most are restricted to exchange-traded derivatives. Patel noted he has spoken to investment managers who have expressed interest in the futures.
