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Derivatives

Dow Jones, Deutsche Boerse Plan European Volatility Index

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Dow Jones Indexes and Deutsche Boerse plan to launch a European volatility index later this month.

boffinbig.gifDow Jones Indexes and Deutsche Boerse plan to launch a European volatility index later this month. The benchmark, called VSTOXX, will be referenced to the EURO STOXX 50 and launched through index provider STOXX, a joint venture between Deutsche Boerse, Dow Jones and SWX Group. The index has been in the pipeline for over a year (DW, 2/29/04). Nicole Wesch, spokeswoman for Dow Jones and STOXX in Frankfurt, confirmed the plans.

Traders said the index launch is timely given the low levels of equity volatility, which mean dealers are hunting for new instruments because investors are hungry for higher returns. Philippe Dardier, head of equity derivative flow sales at BNP Paribas in Paris, said there is demand for different volatility indicators, aside from the German VDAX, a volatility measure on the DAX 40, and VIX, which is referenced to the Standard & Poor's 500. Many investors are looking for new ways of trading volatility, noted Dardier, adding, "Any new benchmark is useful." Dealers said a European volatility index will also likely encourage money managers to trade volatility as an asset class, which has previously been the preserve of hedge fund managers.

Some dealers, however, noted the index methodology needs to be transparent in order for instruments referenced to it to take off. The Chicago Board Options Exchange has not been able to build significant volumes in futures on the VIX and some bankers say this is because there is no precise hedge for them: there is not a one-to-one relationship between the index and its futures. VIX futures give exposure to forward-starting variance, which is volatility squared, rather than forward-starting volatility, which is what the VIX indicates. Dealers, however, said due to modeling problems it is impossible to create pure volatility futures. The most tradable alternative is to have a variance benchmark instead of a volatility benchmark, that way derivatives houses can write options and futures on the variance benchmark and hedge them with the underlying contract.

Officials said there may be more demand for options than futures linked to a European index; the CBOE is launching VIX options (DW, 3/4) and in the OTC market some volatility funds have traded options on variance (DW, 10/1).

Deutsche Boerse is responsible for the methodology of the index, but Wesch declined to detail how VSTOXX will work. Industry officials said Eurex, which is owned by Deutsche Boerse and the SWX Group, has been looking to launch futures or options on volatility. Derivatives houses are also interested in writing OTC products on VSTOXX.

 

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