Find
01 Jun 2022

Eurex | Eurex Clearing

Navigating a New Era of Cross-Asset Volatility

Eurex spoke with Hugo Bernaldo De Quiros, Senior Cross Asset Trader at Optiver about the landscape of volatility in 2022 and how easy it is to find opportunities.

What does the landscape of volatility look like in 2022?

The big theme of the last few months has been rates going up and the repricing of what constitutes most of the S&P500’s market cap. The low rates environment, the WFH trend and the retail frenzy are all reversing as we go back to normal and get rid of monetary policy excess.

While we have had huge drawdowns on world indices, mostly from tech, a shortage of commodities has sent the energy sector up massively.

Energy is a very small part of most indices, but materials and some more defensive equities have been holding up until very recently as tech melted down. That has dampened index volatility, which is partly why dispersion strategies have been working so well YTD. Implied dispersion levels have been grinding higher as a result.

The fundamental backdrop for dispersion is great as many of the trends of the last decade reverse. We have also had quite a few single stock blow-ups, which helps when running that strategy.

The Eurostoxx 50 is a great index to set up this dispersion trade as it has a healthy mix of sectors and good liquidity on both the index leg and most of its constituents.

This rotation is also partly why index convexity hasn’t been working so well on the way down. Correlation hasn’t been there like in your classic risk-off move where index hedges would perform nicely.

Correlation between bonds and equities is the most positive it has been in a very long time. The market is trying to figure out where the new Fed put is and when bonds will be bid as equities sell off. That creates new dynamics for rates skew as well.

A good example of the impact of this sector rotation is an index like the FTSE 100, which has outperformed most if not all other European indices as it has high weighting in commodity-focused and high div-paying stocks. This has large implications for index option pricing.

How is Optiver set up to navigate these rapidly shifting conditions?

The Optiver trading floor is very well connected. That is our main strength - in the moments where liquidity is hardest to find, we can step in and price the tightest. This is because we can access all this cross-asset liquidity.

We have market making teams that are constantly making prices and then we have the spread teams. The latter help with cross asset pricing by taking positions between single stock names, equity indices as well as against bonds or commodities while trading internally with the market makers.

It is very easy to put on an options trade when VIX is at 15 or 20 and the market is quiet. But when you get these moments of illiquidity, it is only really market makers like us who can price tight and warehouse risk because we have all these other sources of liquidity.

Our market share always goes up when volatility goes up.

How hard is it to hedge your exposures in these conditions and how easy is to find opportunities?

Hedging is tricky as volatility is high, so all the explicit equity hedges have largely been bid up. Open interest in S&P500 puts has been falling in tandem with the futures, which is quite interesting. A lot of market participants have been taking off hedges after the drawdown and index skews have flattened considerably. European equity skews are also low by historical standards but not so much as the American Index. If you liked hedging with skew in 2020/21 – when it was at all-time highs, you must love it now!

If you want to go cross asset and proxy-hedge there can be cheaper alternatives but is not that straight-forward. The two assets that are breaking markets at the moment are rates and commodities at the moment so that is a good place to look for correlated alternatives to equity vol to hedge exposures. FX too as a proxy for those two is interesting too.

The financial side of the commodity market isn’t that big and there is not so much room to place huge bets but oil and gold have relatively developed option markets and because of the recent geopolitical backdrop we have seen great dislocations in both of these option markets.

As Optiver, we are expanding our presence in commodities and fx from our London office as these areas become interesting again.

We are also increasingly trying to trade more in longer dated options across all asset classes and serve some of the market’s liquidity issues there as the supply-demand picture tends to be much more lopsided as the events of the last couple of years have taken some vol players out of the picture.

What have conditions been like for spread trading?

Spread trading has always been a profitable strategy but many of the correlations that could me somewhat relied upon and we were all used to are no longer there or are flipping around.

This means more risk for spread trading but at the same time more chance for dislocations appearing as everyone shares this same uncertainty and liquidity can be harder to come by.

One popular vol spread is the SX5E/SPX, which due to the changing themes between the Ukraine war and the tech selloff has seen extreme swings. One of the best ways to play this was through the VSTOXX futures as they isolate the implied component of the trade and save any spread traders much hassle in terms of gamma risk, path-dependency and hedging costs. Liquidity in the volatility futures is good too so the trade can accommodate size.

Spread trading is alive and well!

Market Status

XEUR

The market status window is an indication regarding the current technical availability of the trading system. It indicates whether news board messages regarding current technical issues of the trading system have been published or will be published shortly.

Please find further information about incident handling in the Emergency Playbook published on the Eurex webpage under Support --> Emergencies and safeguards. Detailed information about incident communication, market re-opening procedures and best practices for order and trade reconciliation can be found in the chapters 4.2, 4.3 and 4.5, respectively. Concrete information for the respective incident will be published during the incident via newsboard message. 

We strongly recommend not to take any decisions based on the indications in the market status window but to always check the production news board for comprehensive information on an incident.

An instant update of the Market Status requires an enabled up-to date Java™ version within the browser.