We live in an age of 24-hour news coverage. Indeed, the information at our disposal is greater than at any point in human history. As such, hedge funds and other money managers need to trade the markets as and when news events occur. Such is the interconnected nature of global markets that an event taking place say, in Japan, will likely impact the US.
Back in March of this year, the Chicago Board Options Exchange (CBOE) introduced extended trading hours for VIX options and SPX (S&P 500 Index) options to give global money managers greater flexibility to trade VIX and SPX products outside of normal US trading hours.
SPX is often used by money managers as a proxy for the global market. And VIX is considered the benchmark for global volatility. Traders now benefit from an additional six hours and 15 minutes of trading, five days a week.
This follows the decision by CBOE in June 2014 to extend trading hours for futures on the CBOE Volatility Index (VIX) to nearly 24 hours a day, five days a week.
Every minute counts
As noted, VIX futures trading is available nearly 24 hours each business day.
The market for VIX and SPX options trading opens at 2:00 a.m. CT, which coincides with the opening of the European stock markets in London (8:00 a.m.) and Continental Europe (9:00 a.m.).
A less obvious, though highly important, overlap is with the Asia markets.
A 2:00 a.m. Chicago opening is typically 15:00 p.m. in Hong Kong. That’s important because it allows firms who want to trade VIX and SPX options to see the U.S. market and trade in real time instead of calling their broker to put in an order for later that day, after they’ve left the office.
That is a huge convenience to traders in Asia.
“They can put the order in right away, see what the execution is and get it done before Asia’s markets close,” states Paul Stephens (pictured), VP International Business Development, CBOE.
To extend this point further, US managers will also benefit if a macroeconomic event takes place overnight in Europe or Asia. Now, with the 2:00am market opening, they can react much quicker to these events and adjust the positioning of their portfolio right there and then; for example, the ECB makes a statement at 9:00am European time, which spooks the markets and leads to a spike in volatility. That would allow a New York-based trader, albeit at 3:00am in the morning, to adjust their VIX options exposure.
So extended trading hours can work to one’s advantage no matter where in the world they are located. By reacting quicker than one’s peers, managers can harvest alpha-generating opportunities and improve portfolio performance.
Volatility arbitrage strategies
There are certain trading strategies that benefit from extended trading hours.
Within the hedge fund firmament, volatility arbitrageurs are some of the most active users of SPX and VIX options and VIX futures. They are a niche set of managers, but the amount they trade is quite substantial.
Volatility arbitrageurs trade price inefficiencies for the same contracts that exist in different markets. Although VIX is by far the largest volatility market to trade, there are others, e.g. VSTOXX in Europe and the HIS Volatility Index in Hong Kong.
Now, with extended trading hours, global volatility arbitrageurs have enhanced opportunities to find and trade price inefficiencies in these markets.
“This applies to the SPX options as well,” explains Stephens. “One thing we are seeing nowadays is people looking at the skew on the US market (SPX) and how it differs from the skew in Europe and Asia. Then they’ll put on trades to try and take advantage of that view depending of where markets are priced and where they are likely to go.
“We are happy to see non-US markets grow. We think this is all complementary business. The good news is that the European market has grown quite a bit, albeit from a fairly low base,” he adds.
The global growth of VIX has primarily been driven by fundamental factors rather than structural factors such as extended trading hours or distribution channels, but extended trading hours will support that growth.
Trading volumes are driven by the markets more than anything else, says Stephens
“What we have seen over the last few years is an increasing amount of non-U.S. business. We’ve seen diversion both from a geographic standpoint and a client profile standpoint. Non-US growth is certainly building, but I believe that what drives VIX trading growth is not whether it’s a European trader versus a US trader benefiting from longer trading hours. Rather it is a function of market activity: What is the VIX trading at? Is volatility rising or falling?
“If you step back for a second and look at the introduction of VIX to the equity derivatives toolbox, based on what clients have said and by taking as objective a stance as possible, I would say that VIX is the most important development in the equity derivative marketplace for the last 10 years. It really has changed the landscape,” states Stephens.
This is because people have the ability to trade directly into their view on volatility.
Previously, it was much more labor intensive and complex to get pure volatility exposure.
Because of the ease of access, VIX options and futures have broadened out the playing field and reduced that complexity. Now investors of all shapes and sizes can trade volatility; the upshot being that liquidity has deepened in tandem with the global growth of VIX.
Expanding on the client diversification point, Stephens adds:“When we launched VIX futures in 2004 and VIX options in 2006, in those early days the client base was very much professional and they were predominantly buying protection; on a net basis they were long volatility (e.g., buying VIX futures or calls to protect against large downside swings in equities).
“Nowadays, clients are much more diverse. We’ve got clients who are long volatility to protect their equity portfolios; we’ve got clients who are short volatility and treating volatility as an asset class in and of itself. It is this diversification of clients and the strategies being utilized that has been key to the global growth of VIX and SPX.”
Coming soon: VIX Weeklys futures and options
Two key trends, aside from client and strategy diversification, have stood out at CBOE over the last decade:
1st trend: Introduction of VIX futures and options in 2004 and 2006
2nd trend: Introduction of S&P 500 Weeklys in 2005 and the expansion of Weeklies in 2010
Aside from VIX options and futures, the increased level of adoption in trading SPX Weeklys contracts has been, in Stephens’ opinion, the second most significant trend in the equity derivatives landscape.
Weeklys are options contracts that expire at the end of day each Friday and may be listed with expirations of up to six consecutive weeks out. Weeklys now account for approximately 30 per cent of SPX options traded at CBOE.
“This whole notion of going to shorter dated, more targeted timeframes is a trend we’ve been seeing for quite a while. That’s why we are very excited that in July 2015 we will be introducing VIX Weeklys futures followed by VIX Weeklys options contracts. That will give our clients greater opportunities to more precisely tailor their trading strategies,” comments Stephens.
That investors will be able to choose VIX futures and options contracts that expire on a weekly basis rather than just monthly will add another layer of precision to the way they manage their portfolios.
“To have more expiration dates offers our customers the ability to fine-tune what they want to do. Another important feature is that when a VIX futures contract approaches expiration it behaves more like VIX cash. Right now, VIX futures have an expiration once a month. That means, once a month there is convergence between VIX cash and VIX futures.
“By introducing Weeklys for VIX futures and options, customers will see VIX futures behave more like VIX cash four or five times a month, as opposed to just once a month,” says Stephens.
VIX & SPX daily contracts – A future consideration
So could there, at some point in the future, be a daily contract?
Stephens does not completely rule out the idea.
Again, this is not to suggest that the contract would only exist for 24 hours. Instead, it would be a case of extending the level of precision further by allowing traders to select contracts for expiration on different days of the week, in addition to Fridays in the case of SPX.
“At some point, investors are going to demand more. They are going to say, ‘Hey CBOE, you’ve got expiration on Fridays, how about one on Wednesdays or Tuesdays?’ Now, you can call them dailies, but what I’m saying is that only relates to the day they expire. Not that they exist for just one day and expire.
“Eventually, we’ll get to that position but nobody is putting a timescale on it,” concludes Stephens.
Thanks to extended trading hours and the imminent introduction of VIX Weeklys futures and options, CBOE is enhancing the way that global investors manage their portfolios, and volatility, more effectively.
