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EQDerivatives: "Attention Turns To German, Italian Elections As VSTOXX Solidifies Its Status As Event Risk Barometer"

Release date: 29 Jun 2017 | Eurex Group

EQDerivatives: "Attention Turns To German, Italian Elections As VSTOXX Solidifies Its Status As Event Risk Barometer"

Article by Georgia Reynolds, EMEA Reporter

This article first appeared in EQDerivatives' subscription Commentary & News service.

Despite the French elections coming to a close in June, liquidity in the Euro Stoxx 50 Volatility Index (VSTOXX) has continued to remain strong. The VSTOXX has this year solidified its position as the most efficient underlying to trade event risk in Europe, made evident by increased appetite in recent weeks in V2X Sept. futures as expectations increased for an Italian General Election in October. Georgia Reynolds sets out how market participants are progressively identifying the benefits of the VSTOXX when trading around events and why heightened liquidity in the underlying is here to stay.

As reported by EQDerivatives, the range of trading strategies implemented in the VSTOXX has been increasing rapidly. The underlying saw a 142% increase in monthly volume in May 2017 compared to May 2016. Since November 2016, the VSTOXX has seen significant growth in traded contracts across futures and options, with the French Election driving the flow. In recent months, investors have been buying put calendars, naked April futures as well as novel upside positions on the Euro STOXX 50 (SX5E) contingent on the VSTOXX April futures being to play the implied volatility shift around the French election.

The increased liquidity in the VSTOXX, the introduction of novel trading strategies and the accessibility of the underlying has driven new entrants in to European volatility trading. The increase in VSTOXX liquidity has not been limited to hedging or monetising the French election -Brexit and the upcoming German and Italian elections are driving further trading in the underlying.

Gabriel Manceau, VSTOXX trader at Morgan Stanley in London, told EQDerivatives that more investors are identifying the benefits of the VSTOXX over other European underlyings to hedge event risk in the region. “The VSTOXX futures allows investors to accurately trade an event… They allow you to trade up to eight months in advance the risk of the 30 days period starting at the expiry of the future,” said Manceau. Options in the Euro STOXX 50 for example, which could be used as an alternative, represent spot volatility, therefore capturing the event along with the performance before, he added. “Which is not what you want, as with VSTOXX futures, at first order, you do not trade anything before the corresponding VSTOXX future expiry.”

Earlier this year, Manceau saw a significant pickup in a variety of VSTOXX futures spread trades, specifically in April and May expiries around the French election. “[This is] because it allows you to play the event a long time before you can do it on say the Euro STOXX 50,” he said. “If you trade VSTOXX futures you can exactly trade an event one month around, so it is a lot more accurate for that purpose.”

Mathilde Richardot, equity and derivative strategist at BNP Paribas in London, concurred on the significant pickup being driven in VSTOXX April and May spread trades going in to the French election, noting that the April/May futures spread pricing heightened risk over the election period in line with the two-year French-German yield spread observed in the bond market. “Many investors were considering April’s VSTOXX futures to remain floored while playing post-election risk normalization through May or June tenors,” she said.

Since the French election, Richardot noted that VSTOXX options have priced increasingly expensive, driven by a pickup in tail risk hedging. “Looking at VSTOXX options, VSTOXX at-the-money volatilities have climbed higher from post-French elections lows and now appear relatively expensive when normalized by the level of VSTOXX futures,” said Richardot. “The upside volatility in the front two months is very expensive as we started to see tail risk hedging with the appetite for the 25-delta to 10-delta calls region in July and August being very high, she added.

It is the VSTOXX Sept. futures that have found the bulk of flow from investors in June, however, with talk of an Italian election taking place in October leading investors to position for higher volatility going in to the event. “If you look at previous elections, where April futures for the French elections touched 28 and settled around 25, so now when you have September futures trading below 20 if there is an Italian election in October we could finish well above 20, which would be attractive for investors,” Manceau said.

Although in late June the VSTOXX September/August futures spread deflated and the market started to price Italian elections to occur later this year, it was evident that the VSTOXX was the go-to underlying for the wider trading community. “If you are looking to play the Italian election, or any macro event on a specific date in Europe, investors may look to the VSTOXX as it is an efficient way to do it because it allows them to play a very specific period,” Manceau added.

Georgia Reynolds is a reporter at EMEA at EQDerivatives, based in London.
A recent graduate from City University London, Georgia has been studying and producing print and multimedia journalism for five years.

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