JLN Options - May 26, 2010 [NEWSLETTER]

Commentary/Story/ Q&A

Talking Options on the VSTOXX with Rex Jones, Product Manager at Eurex

Rex Jones is the product manager at Eurex. JLN Options spoke with him about the recent launch of options on the VSTOXX index and what’s next for the exchange’s volatility and variance products.  (“The VSTOXX Index is based on EURO STOXX 50 realtime options prices and is designed to reflect the market expectations of near-term volatility by measuring the square root of the implied variance across all options of a given time to expiration.” – STOXX web site)


Q: When did Eurex launch options on the VSTOXX index?

A: We launched the options on the volatility index VSTOXX on March 22 of this year. It gives investors the ability to trade volatility derived from EURO STOXX 50 options, probably the most liquid options out there – it is the blue chip Euro zone benchmark index.

Q: Were you the main person behind the development of this new product?

A: Yes, I was responsible for the development of options on VSTOXX. This launch follows the relaunch of the VSTOXX mini futures product. Last year after the conundrum of 2008, when things calmed down, we spoke to players in the market and then re-launched the futures on the VSTOXX. We reduced the contract multiplier to 100 euros per volatility index point, based on client feedback that the previous size of 1,000 euros was too big.

The most significant development on the futures side was continuing market making support of institutional trading needs. That started with the market maker support from Dominicé Asset Management, who were joined by Barclays Capital earlier this year. I think this gave us the basis with the underlying out there, to launch options on the VSTOXX, providing market makers with delta hedging opportunities.

We’ve seen some pretty good flows from the institutional side, where bankers are arranging trades for their hedge fund clients who want to trade volatility derived from the EURO STOXX 50 options. A handful of banks are making risk prices and providing execution services; so far we’ve seen trade sizes as big as 10,000 lots.

Q: How much of the trading in these products is screen-based?
A: We have screen liquidity that you can look up on Eurex and Bloomberg through the options monitor, and JP Morgan is our market maker. In Europe, you not only trade on screen but banks are willing to make price offers for block trading. The trades are pre-arranged bilaterally and then entered into the system for central clearing via Eurex Clearing. This is traded volume and accessible liquidity. By contrast, in the US, most options by regulatory mandate go through an online venue.

At Eurex, people can trade either way – on screen or through pre-arranged trades - but banks can also trade amongst themselves, so there is also a true over-the-counter market in Europe for vanilla exchange look-alike options.

We see a ratio of about 50-50 between screen and institutional-sized block trades for equity options. With fixed-income options it’s about 75-25. In the new VSTOXX options the ratio is 85 percent as block trades and 15 percent on screen.

Q: What was the spur for developing these futures and options products?

A: For that we need to look into the past and consider the European market in context of trading volatility and variance.  The US market quickly developed into an exchange traded market with the launch of VIX options in 2006. At that time the European markets were more focused on offering OTC variance swaps.

At the end of 2008 the crisis arose that changed that. There were two types of positions after the Lehman crisis hit and volatility severely spiked. Some volatility arbitrage funds had to shut down after they’d been accustomed to selling implied versus realized volatility. Some players suffered losses, but more importantly, the way these OTC deals were structured is you traded directly against your bank - and that was a risk exposure. The banks were not willing to take on the risk exposure of their clients, and the clients didn’t want to take on risks with banks, which were subject to credit risk. Counterparty risk became real.

Credit lines are now used more cautiously under stricter regulations, and this opened a window of opportunity to establish an exchange-listed and centrally cleared product in this segment. That has increased the probability of success for any exchange traded derivative contract.

Q: Have the contracts been successful so far?
A: Eurex had listed VSTOXX futures initially in September 2005 but had not had much luck with the product until last year. In the first two months we’ve had a daily average of 8.5 thousand contracts in options on VSTOXX. On Wednesday May 19, open interest was at 180,000 contracts prior to expiry of May VSTOXX options. 60,000 of that expired and open interest today is at 125,000. Trading over the last days was quite good so that number should be back up to above 150,000 soon.

Q: Are there any changes ahead for this product?
A: Our next move will be in the number of available contract months. We’ll start off with VSTOXX futures, because we have client requests for more contract months to express longer termed views. After the launch of these new VSTOXX futures contract months, we’re anticipating a similar development and options to follow. Futures on the VSTOXX currently stand at 15,000 contracts open interest and trade about 1400 contracts per day.

Right now we have 3 monthly expiries and 1 quarterly expiration. We hope to extend that to 7 consecutive monthly expiries in June.

Volatility is definitely an established asset class in the US and we’re looking to bring that success to Europe. The first liquidity developments have been promising and we’re pushing the products to our member base and institutional clients.


Lead Stories

ISE Celebrates 10 Years of Leadership and Innovation in the Options Industry
NEW YORK, May 26, 2010 (ISE press release)
The International Securities Exchange (ISE) today celebrates its 10th anniversary and a decade of innovation and leadership in the options industry. ISE launched trading as the first all-electronic options exchange in the U.S. on May 26, 2000, and revolutionized the industry by introducing low fees, transparent markets, and an innovative new market structure.
http://jlne.ws/coyzkE

SEC Approves Proposal For Central Repository For Trade Data
By Fawn Johnson Of DOW JONES NEWSWIRES
WASHINGTON -- The U.S. Securities and Exchange Commission voted 5-0 Wednesday to approve a proposal to require national securities exchanges to give regulators data so that they can aggregate real-time market information across multiple platforms.
http://jlne.ws/cfaLrB

As Volatility Drops Markets Soar
Before It's News
http://jlne.ws/9TzzFi

More Traders On The Move
Traders Magazine Online News, May 26, 2010
Traders Magazine Staff
The Options Clearing Corporation appointed Craig Abruzzo and Valar Mihan to its board of directors. Abruzzo is head of Morgan Stanley's listed derivatives business in the Americas and Mihan is head of Americas equity-linked trading at Bank of America Merrill Lynch.
http://jlne.ws/bPfIjj

Q&A with New York City OTB chairman Frucher
Thoroughbred Times
http://jlne.ws/chIcdX

SR: It's not often that we run a story from Thoroughbred Times, but this one is an interview with Meyer S. (Sandy) Frucher, who was chairman and chief executive of the Philadelphia Stock Exchange and then became vice chairman of NASDAQ OMX when NASDAQ bough the PHLX in 2008. Frucher is also a member of the board of directors of the Options Clearing Corporation.

Options Traders’ Ranks Swell as Amateurs Embrace ‘Iron Condors’
By Margaret Collins and Jeff Kearns, BusinessWeek
May 25 (Bloomberg) -- David Siniapkin, a postal worker in York, Pennsylvania, uses some of his retirement money to trade options. After three years and being down as much as $10,000, he’s broken even.
http://jlne.ws/bJEQeC

Could it Really Be Happening? CBOE IPO Moves Ahead
The Options Insider
The initial public offering for the CBOE is coming closer. CBOE Holdings, Inc. had an amended filing on May 18. While some of the terms are still outstanding, details have emerged on how much is being sold by exchange members (selling holders) and how much will go into the company coffers. The size of this underwriting offering is far larger than any deal seen in recent IPOs.
http://jlne.ws/9f5qwo

UPDATE: Chicago Board Options Exchange Members Approve IPO
Jacob Bunge, WSJ.com
Seatholders of the Chicago Board Options Exchange on Friday approved a plan to convert their memberships to shares in the company, clearing the way for a long-planned public offering.
Member-owners' backing of the deal, which will see CBOE Holdings Inc. float an expected $300 million in shares on the Nasdaq Stock Market next month, marks the last major step on a four-year road for the world's fourth-largest derivatives exchange by contract volume.
http://jlne.ws/93Y742

BATS Options finishes rollout of option classes
Doris Frankel, Reuters
BATS Options, the newest U.S. options exchange, said on Monday it is offering options on 2,121 underlying equity securities for trading with the completion of its roll-out of option classes. BATS also said it won approval from the U.S. Securities and Exchange Commission to eliminate the requirement of at least one registered options market maker for each option series before it may be opened for trading on the exchange.
http://jlne.ws/cSQ32V

CBOE Parent Could Face $300 Mln In Damages In ISE Suit
Jacob Bunge, WSJ.com
CHICAGO (Dow Jones)--The Chicago Board Options Exchange, preparing for a long-anticipated stock market float, is facing a $300 million damages claim from a rival in a patent-infringement case.
The International Securities Exchange is seeking $300 million or more in damages after suing the Chicago exchange operator for alleged copying of its trading technology, according to a recent court filing.
http://jlne.ws/aCGFhz

TD's Bradley to advisers: Ignore options at your own peril
Head of discount brokerage's custody arm says larger firms already talking up the virtues of the financial instruments; expand ‘beyond asset allocation'
By Hilary Johnson, Investment News
Advisers need to boost their use of options — or possibly risk losing business to larger rivals.
http://jlne.ws/aHoP8K


Exchanges

ISE's 2009 Annual Review
http://www.ise.com/ar2009/

Fear gauge surges on the Street
dnaindia.com
Mumbai: Implied volatility, a measure of how wild a ride investors expect to see in the near future, has hit levels not been seen in the last eight months. In simpler language, that would mean the worst may not be over.
The volatility index or Vix, a ripoff of the Chicago Board Options Exchange index by the same acronym, the so-called ‘fear gauge’, touched 34.52 on Tuesday — a number last seen in the beginning of September 2009.
http://jlne.ws/bCK3gf

CBOE, CFE and CBSX Trading Schedule for Memorial Day
http://jlne.ws/bWgra8

Eurex to Introduce Further Options on ETFs
New contracts will be based on ETFs issued by Source/ Launch on 1 June 2010 25. May 2010
The international derivatives exchange Eurex announced today that it will list seven new options on Source ETFs on 1 June 2010. One new contract will be based on the STOXX Europe Mid 200 Source ETF, the further six options will be based on the STOXX Europe 600 Optimised Supersectors Source ETFs covering the sectors Banks, Basic Resources, Industrials, Oil & Gas, Telecommunications and Utilities. The launch of the new ETF options will complement the recently introduced options based on three benchmark index ETFs.
http://jlne.ws/dcgkJU

NASDAQ at New Lows
TradersHuddle.com - Trade Alert
Shares of NASDAQ OMX Group, Inc. (NASDAQ:NDAQ) booked a new 52 week low by trading below $17.63, traders are definitely monitoring NASDAQ's price action to see if this move attracts further selling, or it this last push down sets a tradable bottom in the stock.
http://jlne.ws/c0ZY7D

Deutsche Börse publishes second Corporate Responsibility Report Deutsche Börse has published its second Corporate Responsibility Report, presenting its initiatives for the concluded financial year 2009. The report was prepared and examined in accordance with the internationally recognized Global Reporting Initiative (GRI) guidelines, thus lending it transparency and international comparability. It is available on the company's web site.
Episode 56 - Live From OIC: NASDAQ OMX and PHLX
The Options Insider
An Options Insider radio program from the OIC conference in Phoenix. NASDAQ OMX/PHLX exchange leaders discuss the fact that so many exchanges are copying PHLX by swapping ownership for order flow and the claims that NASDAQ and BATS are cannibalizing the options market. Finally, they debate PHLX's controversial pursuit of dividend trade volume. Does this strategy exploit retail traders and distort the overall options market?
http://jlne.ws/9Ro5o7

VIX-futures ETN rises near 2010 high
By John Spence, MarketWatch
The iPath S&P 500 VIX Short-Term Futures ETN (VXX 34.16, +1.04, +3.14%) rose as much as 9% during Tuesday's stock sell-off but pulled back a bit for a session gain of about 4% in afternoon trading. The exchange-traded note is designed to follow near-month futures contracts on the CBOE Volatility Index...
http://jlne.ws/cm3XqT
CME stands to cash in on trading frenzy
...And while investors are wondering how much financial reform will take out of the banks' pockets, the push toward clearinghouses and other moves to make markets more stable and transparent could help the exchanges. CBOE Holdings, the operator of the biggest U.S. options exchange and CME's crosstown rival, is planning an initial public offering based in part on this notion.
http://jlne.ws/a6xYeR

CBOE'S S&P 500 INDEX OPTIONS (SPX) VOLUME BEATS ALL-TIME DAILY HIGH
NEARLY 2.19 MILLION SPX CONTRACTS CHANGE HANDS ON THURSDAY
-- total trading volume at CBOE marks second most active day ever
-- ETF options set new daily record
CHICAGO, May 21, 2010 - The Chicago Board Options Exchange (CBOE) today reported that trading volume in S&P 500® Index options (SPX) contracts on Thursday, May 20 established a new daily record with 2,187,004 contracts traded. Thursday's SPX record surpasses the previous daily volume record of 2,170,870 contracts traded on October 6, 2008. Additionally, on Wednesday, May 19, SPX volume totaled 2,146,625 contracts, the third-highest volume day in the contract's history.
http://jlne.ws/b8GqEq


Regulation

SEC proposes high-frequency trade oversight rules
By Ronald D. Orol, MarketWatch
http://jlne.ws/baU0Rk

Letters to the Editor: We Are Not Asking the Fed for an Unsecured Backup
WSJ.com
http://jlne.ws/doE3K0

A letter to the editor by Wayne P. Luthringshausen, Chairman and CEO of The Options Clearing Corporation, on clearinghouse access to the Federal Reserve discount window

New financial rules might not prevent next crisis
By DANIEL WAGNER and STEVENSON JACOBS, Bloomberg BusinessWeek
WASHINGTON - The most sweeping changes to financial rules since the Great Depression might not prevent another crisis. Experts say the financial regulatory bill approved by the Senate last week, and a similar bill that passed the House, include loopholes and gaps that weaken their impact. Many provisions depend on the effectiveness of regulatory agencies -- the same agencies that failed to foresee the last crisis.
http://jlne.ws/aiPzeT

Lexology - New circuit breaker proposed for individual stocks
The Exchange and FINRA Proposals do not by their terms apply to transaction in stock options. However, a trading pause that occurs with respect to an individual equity security would likely lead to a trading halt in the related option. In this regard, the options exchanges already have rules in place allowing them to suspend trading on an option in the interests of a “fair and orderly” market. One of the factors to be considered in such determination includes when trading in the underlying security has been suspended in the primary market. See, e.g., NYSE Arca Rule 6.65 and Chicago Board Options Exchange Rule 6.3.
http://jlne.ws/9BNAfP

New U.S. trading curbs will cause more uncertainty
By Jonathan Spicer, Reuters; additional reporting by Doris Frankel in Chicago, Leah Schnurr in New York and Rachelle Younglai in Washington
...The new breakers for Standard & Poors 500 index stocks trip when they fall or rise 10 percent in 5 minutes, halting trading for 5 minutes. These details could be adjusted and exchange-traded funds might be added, the SEC said. Trading in equity options contracts will also pause when the underlying stocks are halted.
http://jlne.ws/a8m3mo

Senators press for flash crash answers
By Rachelle Younglai and Jonathan Spicer, Reuters
WASHINGTON/NEW YORK - Frustrated lawmakers pressed regulators to move faster to pinpoint the cause of the mysterious May 6 market crash, with two weeks of investigation producing few answers.
http://jlne.ws/a2IjX9


Technology

WhenTech Announces Opening of Chicago Office
PR-CANADA.net
Wednesday, 26 May 2010
WhenTech LLC, a premier provider of option pricing and risk management solutions to the commodities futures industry, announced that it has expanded its operations through opening an office in Chicago. The new office will handle sales and support for the growing number of Chicago-based WhenTech Markets® customers and WhenTech institutional partners.
http://jlne.ws/doCuzm
UNX Secures Funding to Expand into Multi-Asset Trading and Global Markets
By Ivy Schmerkin, Advanced Trading
...“We are eager to build out multiasset classes in the Catalyst portal and offer access to global markets,” said Thomas Kim, CEO of UNIX, in an interview with Advanced Trading last week. Kim said he’s use the funding, in part, to develop electronic trading functionality for options and futures and extend its order routing and trading network into Europe.
http://jlne.ws/aQ8az7

Caerus Trading selects Orc Trading for expanding market making operations
Stockholm, SWEDEN, Tuesday May 25, 2010
InfoTech News
Orc Software (SSE: ORC), the leading global provider of technology for advanced trading and connectivity, today announced that Caerus Trading BV, an Amsterdam-based market making firm, has selected an Orc Trading solution to support its market making operations, which is primarily focused on listed equity and index options trading.
http://jlne.ws/d6Vnn4

Pipeline Announces Liquidity Builder -- The First Multi-Asset Liquidity Aggregation System for Buy-Side Equity Traders
NEW YORK, NY--(Marketwire - May 24, 2010) - Pipeline Trading Systems LLC, a leading electronic brokerage for institutions, announced today the deployment of Liquidity Builder™, a new service that monitors liquidity across multiple cash equity and options markets, and predicts the availability of Pipeline-qualified large blocks. The aggregated small order liquidity is offered at the NBBO in Pipeline-sized blocks of the underlying equity security.
http://jlne.ws/bZXvlJ

Buyside Warms Slowly to Options Algos
Peter Chapman, Traders Magazine Online News
It's a tough slog for brokers championing the electronic trading of options. According to a panel of experts assembled at this year's Options Industry Conference, the options industry is five to 10 years behind the cash equities business when it comes to servicing block orders with algorithms. While the big brokers are managing to cope with the rapidly changing market structure, they face roadblocks when it comes to broadening the appeal of electronic trading to their buyside customers.
http://jlne.ws/9iPpqh


Strategy

A Limit On Volatility
Striking Price Daily
S. Sears - Barrons.com
...As problems in European and Asian markets once again slam American bond and stock prices, investors and traders are talking now about how they can take more control over their stock and options positions.
http://jlne.ws/9Ih783

Citigroup in Most-Active Camp Again
NEW YORK—Options traders have fallen in love with Citigroup. And Monday was no exception.
Tennille Tracy, Barron's.comFor several months, traders have flocked to buy and sell millions of options on Citigroup, either speculating on the direction of the New York bank's stock or protecting the shares they hold.
http://jlne.ws/cNd7H9

Surviving In Interesting Times
The Options Insider
Over the last few weeks traders have experienced a sea change in the volatility environment of the market; we have gone from a milieu in which implied volatility (IV) was low and was perhaps establishing a new long term reality to the current state of accelerating IV in a wide range of underlyings. As one of the three primal forces impacting option prices, it is important to consider the effects this new turn of events brings.
http://jlne.ws/daz18T

Be the Best Investor You Can Be
Dan Caplinger, The Motley Fool
In today's topsy-turvy markets, you need every advantage you can get. Making sure you have the right broker to fit your investing style is crucial to your overall financial success.
http://jlne.ws/9dIADg

Smart Money survey on brokers found OptionsXpress No. 2 for frequent traders (Fidelity was No.1) and Schwab and TD Ameritrade best in research.

A Nifty Volatility Trade
Striking Price Daily
S. Sears - Barrons.com
...Even though the Chicago Board Options Exchange's Market Volatility Index (VIX) recently capped its most volatile two-weeks in its history, strategists and traders are starting to tell clients to get in on the action.
http://jlne.ws/bzW9z3

Volatility Trading Digest: Finding Relative Strength
The Options Insider
iShares Russell 2000 Index (IWM): Although the relative strength of the iShares Russell 2000 Index (IWM) over the SPDR S&P 500 Index (SPY) has diminished recently it still has the advantage for upside moves.
http://jlne.ws/9BvLQj

CBOE S&P 500 Volatility Index (VIX) bear call spread
ONN.tv
Trading CBOE S&P 500 Volatility Index (VIX) options is not for the faint of heart, the options are European style and many of the “normal” rules and characteristics that apply to equity options don’t apply here.
http://jlne.ws/cJXpni

The Perils of Predicting Volatility Striking Price Daily
Bill Luby for Barrons.com
GIVEN ALL THE RECENT volatility in the financial markets, some investors are no doubt wondering how difficult it is to predict future volatility. The short answer is that volatility predictions have a habit of making even the best market professionals look foolish.
http://jlne.ws/9ePndj


Options Education

Don't Be Greedy - Always Buy Back Your Short Options
Posted on 5/26/2010 in Education by Josip Causic at The Options Insider
One of the questions that often comes up in many of my option classes when teaching the credit spread strategy is what to do with the short leg. This entire article will focus on providing a clear answer to that question, while covering all other relevant details.
http://jlne.ws/a9teQA


Events

IDX 2010: 3rd Annual FIA/FOA International Derivatives Expo
When: June 8-9, 2010
Where: London, England
Full info: www.idw.org
Details:
The Futures Industry Association and the Futures and Options Association are pleased to present the third International Derivatives Expo. Last year's event boasted more than 40 exhibits showcasing the latest in products and technology for the derivatives industry, plus 30+ sessions with high profile speakers, information-packed workshops, and endless networking opportunities.

5th Annual FIA and OIC New York Equity Options Conference
When: Oct. 4-5, 2010
Where: New York, NY
Full info: www.futuresindustry.org/2009-ny-equity-options-conference
Details:
The Options Industry Council and the Futures Industry Association have partnered to coordinate the fourth New York Equity Options Conference. Last year, more than 350 delegates representing more than 138 firms attended, including representatives from brokerage firms, funds, exchanges, regulatory organizations, law firms, service organizations, and members of the press.

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