Eurex, Eurex Clearing, Eurex Group
As a further step to facilitate the off-book price formation process on our RfQ platform Eurex EnLight, Eurex Exchange is enabling option volatility strategies (OVS) for Single Stock Equity Options as of November 2019. We spoke with Philipp Schultze, Head of Equity & Index Sales EMEA at Eurex, about the benefits of the new offering and what market segment is going to be targeted with this new service.
What is the general use case and need in the market for option volatility strategies and which market participants are trading those trade combinations?
The purpose of an option volatility strategy is to combine an option and its respective underlying in one trade in order to eliminate the delta risk attached to an option position. The exchange of an underlying delta enables the Market Maker to price an option more aggressively than the option is priced without considering a potential execution risk of the underlying and its respective market impact. The usage of these kind of strategies is very broad, main users are professional market participants trying to trade volatility as isolated as possible.
Option volatility strategies are a common strategy type at Eurex for equity index and fixed income products. How does the single equity options market differ in comparison?
In equity index products, options volatility strategies are a very common traded combination. In EURO STOXX® 50 options, around 68 percent of all traded strategies are in combination with the underlying futures, in relation to the overall volume this reflects up to 36 percent of traded volume*. In Single Stock Options the workflow slightly differs compared to the index segment. While the strategy as such is similarly popular, Eurex so far has only offered the isolated option trade.
Can you provide an example how option volatility trades in Single Stock Equity Options are executed in practice and what benefits the new Eurex solution offers?
While the option is traded and cleared at Eurex, the underlying delta, i.e. the shares of the underlying, are mostly traded back-to-back bilaterally between the involved members.
This process requires bilateral agreements between the counterparties and needs risk and compliance monitoring by every single member. The new Eurex solution offers to trade the combination of option and underlying physical settled single stock futures via one trade either as an off-book, Eurex EnLight or on-screen trade. Because the entire trade and settlement process is processed within the CCP framework, there is no bilateral risk exposure at any time during the trade and clearing process. It enables market participants to trade the combination of option and corresponding underlying futures with every counterparty at Eurex without considering any bilateral risk or compliance limits.
How does the technical implementation of the new offering work exactly?
Eurex will offer option volatility strategies for single stock options with the respective physical settled single stock future as the mapped underlying. The physical settled single stock futures have a monthly expiration cycle; the expiration can be selected when setting up the strategy. As a starting point, the universe will cover 61 underlyings, consisting of the EURO STOXX® 50 components plus a selection of Swiss underlyings. The physical settlement of the underlying shares is triggered at expiry through the common expiration process at Eurex.
What future developments can be expected?
We believe this new solution already offers a substantial improvement in the process of volatility strategies compared to the current processes. However, we understand that there is a basis and liquidity risk during the period between the trade and the expiration of the underlying future compared to an immediate exchange and settlement of the underlying shares. Therefore, there are ongoing efforts to offer a solution with immediate exchange of the underlying shares in form of either a daily settled single stock future or in combination with Deutsche Börse cash market Xetra®.
*based on HY1 2019 figures
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