Volatility derivatives are appealing to an increasingly diverse range of investors who are contributing to the substantial growth of the product, in terms of both volumes and new offerings.
Known throughout the market as the fear gauge, CBOE’s Volatility Index (VIX) is one of the most actively used hedging tools in the US.
Measuring the market’s expectations of 30-day volatility linked to the S&P500, the VIX allows investors to hedge their stock positions, and is now attracting a range of new participants.
“We are seeing a significant surge in CBOE VIX options trading due to increased demand from funds and hedge funds in addition to an increased usage among general investors, accessing volatility derivatives products through their brokers,” said to Jose Ribas, global head of derivatives and structured products, Bloomberg.
“We are seeing much higher usage from the private banking sector and general investors who are using strategies on the VIX, both for hedging and yield enhancement - such as the sale of call spreads.”
For evidence of the rapid growth you need to look no further than CBOE’s VIX futures and options volumes over the past few years.
Trading of VIX options peaked at 16m in October 2013, double the activity seen two years earlier, while the futures equivalent has quadrupled in volumes to 4m in the same amount of time.
JJ Kinahan, chief strategist of TD Ameritrade, believes part of this boost has been down to an increase in participation from retail traders.
“I think the retail trader has definitely increased their exposure to volatility related products, in fact, we have seen our daily average trades in volatility related products up over 1000% year over year,” he said.
“The reason they have done so is twofold, the first is because the education on these products has increased so significantly over the last few years.
“The other primary reason they have started to use these products heavily is that they have learned that volatility itself can be a tradable commodity in the futures and options markets.”
Awareness of volatility products and their uses as an effective hedging tool has been growing among investors.
One example of this is in Europe, where participation in trading US volatility products has risen over the past three years.
More sophisticated use
According to research from TABB Group, only 6% of European investors were using volatility options in their strategies in 2011, compared to 62% in 2014.
“European investors are becoming more sophisticated in their use of options, moving beyond traditional overwriting strategies to enhance returns,” said TABB’s Andy Nybo.
As a result of the growing interest in volatility products, the products have also advanced.
From June 22, CBOE will introduce near 24-hour trading on its VIX futures to capture more business from Europe and Asia.
CBOE has committed to expanding in Europe by establishing a London hub, while Asia is widely tipped as the region holding the most potential for growth in the derivatives markets.
The Chicago-based exchange has also launched futures and options with weekly expirations on the new CBOE short-term volatility index, which tracks nine-day volatility.
The options sparked immediate interest with over 3,000 contracts changing hands on the first day.
“We expect volumes to quickly increase, in a similar manner to the volume spike which occurred during the launch of weeklies on the Standard and Poor Index (SPX), options listed with one week to expiration,” added Ribas.
Edward Tilly, CEO of CBOE Holdings, said earlier this month the exchange is planning to launch the first ever volatility index futures contract on interest rates by the end of the year, pending regulatory approval.
"Other VIX product developments in the pipeline for 2014 include futures on the CBOE/CBOT 10-year US Treasury Note Volatility Index, the first volatility index based on US government debt," added Tilly.
"Diversifying our base product line across asset classes is an area where we see significant potential for growth.”
Elsewhere, CBOE’s rival International Securities Exchange (ISE) is set to arm itself with its own measure of volatility, by listing options on Nations VolDex index later this year.
The launch will pit ISE’s at-the-money offering up against CBOE’s out-of-the money options, with index provider NationsShares believing its VolDex will be an ‘alternative’ to the CBOE Volatility Index (Vix).
Volatility products have also been launched in Russia, India and Hong Kong in recent years.
With new participants and new markets adopting volatility derivatives as an effective hedging tool, the products look set for an extended period of growth.