VXEEM - Emerging Markets Volatility Index Futures Coming To CBOE

CBOE announced that they are launching VXEEM futures on January 9th 2012, and I think there is a good chance the product will take off. At the time when CBOE launched GVZ futures they did not have DPM, however they do have DPM now for VXEEM futures. Also VXEEM has similar dynamics to the VIX, and hopefully that will create some liquidity spillover. Of course I should mention in the timeline of listed volatility products there are many more delisted and inactive volatility products than there are successful ones, but I hope  with coming listings of volatility products (VNKY, VHSI, etc) that we will finally see volatility futures as the first-rate products.

P.S. No date for VXEEM options launch.

VHSI Futures: HSI Volatility Index Futures to Trade on HKEx

Another exciting development in the world of listed volatility products: Hong-Kong Exchange announced listing of futures on VHSI Index at the end of February 2012. This will bring the number of volatility futures products to 5 adding to VIX in the US, VSTOXX in Europe, RTSVX in Russia, VNKY in Japan that are also being launched next year.

News release with product specifications here, Risk magazine article here.

Two months ago I actually mentioned the possibility of VHSI futures on my blog:  "Hang-Seng Indexes Company announced some technical changes to calculation of VHSI - HSI Volatility Index. I am speculating that there is usually no reason to change index methodology unless the exchange is planning to do something, and it may indicate the first step toward Hong-Kong volatility derivatives"

P.S. See my update on VHSI Futures here. 

Expiration Analysis

VIX and VSTOXX finished at their lowest levels in months: VRO - VIX expiration value for December is 21.36, and VSTOXX Index closed Wednesday session at 30.26. Both numbers are siginificatly lower than the forecasts that I made last month, as the markets reacted to a number of good news items from Europe, and possibly end of year seasonality. My direction forecast for VIX was correct, while VSTOXX was not. This unfortunately seems to be the pattern lately - my VIX forecasts are more accurate on the direction than VSTOXX, especially when direction signals disagree.

My forecast for next expiration is for VIX to close at 23.10 vs 24.50 in the futures, and VSTOXX to close at 30.48 vs 32.25 in the futures. Futures prices are Wednesday settlement prices. As before all the forecasts are saved in forecasts tracker page.

Leveraged ETFs: Volatility Skew 2

In the last post I mentioned two models that I developed for translating volatility skew of a main, liquid ETF to volatility skew of a leveraged ETF. Even though these models are not in production (or even production quality, at this stage) I cannot disclose the formulas. However I wanted to show something, so I created these plots to illustrate them on a concrete example: fitting volatility data of SPY etf (january expiration, static snapshot of the data taken few days ago) and creating volatility skews for SSO, SH, SDS, and SPXU.

Market implied volatilities (mid) are in blue. Two models - "red" and "green", with maximum absolute error in vol points between model and market. Neither of the models performs excellent, but red model seems to be particularly bad. Models particularly disagree in the extreme tails, which is not really surprising. If I will have the time, in the following post I will compare results from my models to Zhang's non-parametric approach.

Leveraged ETFs : Volatility Skew

There is very little research available on taking volatility skew from regular (liquid) ETF and producing skew for inverse / leveraged ETF. Another related problem is producing consistent volatility skews between ETFs with the same underlying but different leverage factors.

The only source that I know of is PhD thesis of Jian (Stanley) Zhang, "Path-Dependence Properties of Leveraged Exchange-Traded Funds: Compounding, Volatility and Option Pricing" available for download here. The author presents 3 approaches to the solution.

1. Author calibrates observed liquid options prices to Heston model and computed options on leveraged ETFs using MC. 
2. Second approach is to compute prices of options on leveraged ETF as linear combination of "regular" ETF options, a-la var swap from options prices.
3. Non-parametric skew model that translates "regular" ETF skew into leveraged ETF skew.

While research is certainly groundbreaking, these approaches suffer from some shortcomings. The first two are not directly application to American options, while the third lacks theoretical justification.

In the following posts I would like to elaborate on Dr Zhang's nonparametric approach, as well as two parametric approached that I developed.