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EQDerivatives: VSTOXX Straddles Considered Attractive Due to Low Correlation

Release date: 03 Nov 2017 | Eurex Group

EQDerivatives: VSTOXX Straddles Considered Attractive Due to Low Correlation

Article by Georgia Reynolds, EMEA Reporter

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

Investors should look at adding EuroStoxx 50 Volatility Index strategies to their risk premia portfolios for diversification, due to low correlation between VSTOXX straddles and European equities.

Since 2010, both volatility RP and volatility-of-volatility RP strategies have been positive in the U.S. and Europe, said Christian Kober, strategist at Barclays in London. The highest RP can be found in the CBOE Volatility Index and VSTOXX, he added. “The [VSTOXX] VRP has a moderate correlation to the SX5E VRP and equities, [which] can bring diversification to risk premia portfolios,” he said.

Gabriel Manceau, VSTOXX trader at Morgan Stanley in London, said it is interesting to see such a low realized correlation, “and I see structural reasons for that.” In the current low realized vol environment, the noise between equity spot volatility and VSTOXX volatility will dominate in the relationship, he added. “In case of an important risk-off event in the market, I am expecting this correlation to be much higher,” he said. Fundamentally, Manceau expects selling VSTOXX vol would win more often than selling regular equity vol. “But you should also expect bigger draw-downs in case of a downturn,” he noted. “It also means that this strategy could hit trader stop-loss quicker.

While there is currently no market for VSTOXX variance, strategists at Barclays explained comparable returns can be achieved by a simple at-the-money straddle, specifically selling one-month at-the-money VSTOXX straddles on the expiry, daily delta-hedged, roll monthly.

“Selling [VSTOXX] straddles is only moderately correlated to European equities with an average correlation of 15% since 2010,” Kober explained. The VVRP is not too correlated to the SX5E VRP (one-month variance) either, with a correlation of 35% over the same period, he said.

“There is an important pin risk with vol options around expiries,” Manceau added. Pin risk is when the market moves strongly against you on expiry. “If it happens on your expiry, on your strike, and you are on the wrong side of the move, you can lose the entire p&l made just on the expiry,” he said. This is what makes vol-of-vol expensive. “You have such a big expiry risk that straddles will stay expensive until the last minute, and on expiry day you can all your risk premia or lose it all.”

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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