Following the Chicago Board Options Exchange’s (CBOE) third annual Risk Management Conference Europe, which took place near Dublin, Ireland in September, SRP spoke to Paul Stephens, head of institutional and international marketing at the options exchange, about the strategies made available to structured product providers by CBOE’s array of established and upcoming products.

Do you see the structured products space as a marketplace in which you can increase CBOE’s footprint? What kind of opportunities does CBOE’s Volatility Index (VIX) or any other CBOE index offer to the structured product space?
Yes, structured products are an important source of business for CBOE. Structured product providers are increasingly looking for innovative ways to build value and CBOE provides the products and tools that are the raw materials for such innovation.

Options and volatility-based indices are particularly interesting in this respect. For instance, CBOE has options-based strategy benchmark indices that track covered call writing such as the CBOE S&P500 Buy-Write Index (BXM). BXM tracks a hypothetical strategy that holds an S&P500 stock index portfolio, with dividends, and sells S&P500 call options against that portfolio.

A few years ago, we saw the BXM index getting some traction among structured products providers. In what way is BXM useful for structured product providers?
Many investors, including structured product providers, replicate the strategy behind the BXM Index. BXM can also be used as a benchmark index to gauge the performance of other, options-based strategies. Whether investors replicate the strategy as is, or use it as a benchmark for similar strategies, the motivation is similar; the goal is to obtain better risk-adjusted returns than simply holding the S&P500 stock portfolio. Over the long haul such performance has been the case. The BXM strategy has achieved returns similar to that of the S&P500 Index itself, but with approximately 30% less risk.

Do you think other indices such as the CBOE/CBOT 10-year US Treasury Note Volatility Index could be similarly successful?
I think so. Interest rate derivatives represent a larger asset class than equity derivatives and we’re excited to tap into this space for the first time. We began disseminating daily values for the CBOE/CBOT 10-year US Treasury Note Volatility Index (VXTYN) last year and now we’re gearing up for the launch of trading of VXTYN futures on November 13. We expect that VXTYN futures will be used as the basis for structured products much in the same way VIX futures and options have been used.

What kind of opportunities are there for ETNs linked to the VIX? Why are volatility derivative products in such demand now?
Exchange-traded products (ETFs and ETNs) based on VIX futures and options have been in existence since 2009. The number of such ETPs has grown through the years and today there are dozens of VIX-linked ETPs with billions of dollars in assets under management. I think the demand for volatility derivatives is increasing because a growing number of investors are looking for innovative ways to generate yield and/or protect assets.

The CBOE Volatility Index has become the de facto measure for market volatility, not just in the US, but worldwide. VIX options and futures provide the opportunity for more of a pure volatility hedge. Furthermore, with our extended trading hours in VIX futures, and the launch of extended hours for VIX options later this year, investors have the ability to react more quickly to geopolitical news and events impacting the market.

The VIX Index has been one of CBOE’s crowning achievements and for over 20 years, it has been the go-to index to measure volatility (or investor fear) in the market. What do you think of Nations’ VolDex index? Has it represented a challenge for CBOE? Is there room for more than one provider of a measure of implied volatility?
It’s not unusual to see competition when you have a successful product. However, we have great confidence that the VIX Index will remain the premier volatility benchmark.

VolDex is a measure of implied volatility using at-the-money options. As we recognized 20 years ago when we launched the original VIX, using at-the-money options is certainly a reasonable way to measure volatility, but not the only way. We redesigned the VIX Index in 2003, transforming VIX into a tradable measure of volatility. The VIX Index formula provides a blueprint for a stable hedge that can be replicated using wide range strike prices of SPX options, one of the most liquid and closely watched index option contracts in the world.

We do not believe that at-the-money volatility is directly hedge-able. I think if VolDex options have any measure of success, it will be because traders will be able to hedge using our highly liquid market for VIX futures and options.

A number of exchanges have recently moved to bolster their indexing capabilities. What is your take on this development?
We think that index-related products add a lot of value for investors and we welcome the complementary work from other exchanges. CBOE has been a leader in index options for over three decades and we work closely with our indexing partners at S&P Dow Jones, Russell and Nasdaq to grow the business.

In the volatility space, we’ve recently formed the VIX Network, a global network of exchanges with agreements regarding use of the VIX methodology. We are meeting with exchanges around the world to help them successfully develop volatility products in their own markets.

Has the recent regulatory overhaul had any impact on the way CBOE does business?
We see an opportunity in the OTC space, in particular, as regulatory changes may force business from OTC to the listed market. In this regard, we believe that CBOE’s product line leaves us well positioned to benefit from this shift.

In fact, we are already beginning to see some OTC-type trades migrate to CBOE. While we continue to look to product development, such as variance futures, to attract that business, our SPX FLEX options product is uniquely tailored to meet the customization needs of OTC participants.

What has CBOE got planned for the future? What kind of products are you looking to develop?
As the leading innovator in the options industry, we always have new products in the pipeline. We think we’re still in the early stages of volatility as an asset class, so that will continue to be an area of emphasis for us. As we saw at our CBOE Risk Management Conference Europe in Dublin a few weeks ago, there is tremendous interest in trading VIX and volatility. We are excited about the opportunities in the volatility space and are looking to expand and diversify our roster of volatility-related products to meet customer demand. Specifically, we will be looking to add more benchmark indices, strategy-based indices, and tradable futures and options contracts on these indexes.

Related stories:
CBOE: Fixed income volatility is non-existent in the OTC space
Volatility to get traction in Asia markets
CBOE gears up on 10-year Treasury Note VIX futures launch