Schroder Salomon Smith Barney, Morgan Stanley Dean Witter and Commerzbank are pitching long DAX volatility trades to proprietary accounts and hedge funds to take advantage of a slump in implied vol to three-year lows. Greg Wolters, v.p.-equity derivatives sales at Credit Suisse First Boston in London, said two to three times the normal volume of DAX vol trades have gone through the over-the-counter market in the last two weeks. Typical positions being entered include vol swaps, straddles, strangles and calendar spreads.
Despite the fall in DAX vol, for example implied volatility on the September maturity volatility swap was trading at 21.5% last week, versus an average realized vol of 24.5%, traders expect vol to rise again as the component stocks rally in unison. Low correlation between stocks in the DAX has pushed vol lower, explained Dharmendra Patel, equity derivatives strategist at SSSB in London. However, he believes further interest rate cuts could cause an across-the-board rally, driving vol higher.
CSFB's Wolters is more cautious. He noted that DAX vol went as low as 10%-15% five years ago and fears it could still drop a couple of percentage points lower.
SSSB is recommending investors enter a volatility swap maturing in September, in which they receive realized vol and pay the current market quote for volatility at the time the trade is put on.
Thomas Luthardt, equity derivatives trader at Commerzbank in Frankfurt, is suggesting investors sell at-the-money three-year calls and buy at-the-money five-year calls to catch rising volatility in the long end. The spread on this trade was 8.7% on Wednesday. The historical performance of the index suggests that volatility has further to rise in the long end than the short end.
"This is a vol buying opportunity for hedgers ," said Vincent Marie, equity derivatives strategist at Morgan Stanley Dean Witter in London.
DAX 235 Day Rolling Realized Vol and Average Realized Vol