Strong flows of options-based equity investment products in Japan have dampened implied volatility on the Nikkei.
According to estimates by Citigroup, USD2 billion-worth of structured investment products were issued in September, approximately double an average month. The weight of this issuance dragged two-year Nikkei implied vol to 16.5% last month from 19%. It has also prompted a spate of variance swap trading to play on Japanese equity volatility versus the Standard & Poor's 500 and Euro STOXX 50. Strategists at the firm noted it is an attractive carry trade, as Euro STOXX and S&P variance are expensive in comparison with Nikkei.
The compression of Japanese implied vols is also tipped to continue. If the Nikkei reaches 17,000--it was about 16,400 as DW went to press Thursday--this could trigger another spate of structured issuance, as it is a call level for a chunk of equity investment products. Citi estimates December might see this bumper crop of issuance again affect Nikkei implied volatility levels.
