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Utilizing European volatility during the current market conditions

05 Jun 2014

Utilizing European volatility during the current market conditions

The political uncertainty in some Eastern Europe countries caused volatility and stress in the European equity markets. This article examines the recent volatility in the EURO STOXX 50® Index and the corresponding price moves in the VSTOXX® volatility index. Could the VSTOXX® volatility index offer portfolio diversification during these moments of uncertainty? Does it offer a more efficient diversifier for European equity exposure than other volatility indices? This discussion includes two perspectives; the hedger (investor) and the trader.


Table 1: VSTOXX® Futures yearly volume and open interest as of April 2014

Liquidity is always important to an investor or trader. Table 1 gives readers an overview of the developments in VSTOXX® Futures liquidity over the last years.


Chart 1: EURO STOXX 50® Index (left axis) and VSTOXX® spot price (right axis). 20 September 2013 to 28 April 2014.
Source: Bloomberg data

Since last September, the EURO STOXX 50® Index has trended higher. However, before the Ukraine crisis began the equity market experienced a correction of -6.51% between 15 January 2014 and 5 February 2014. During this same time period VSTOXX® spot market rallied 37.19%.

As the situation unfolded, several moments of equity corrections appeared from 25 February to 3 March EURO STOXX 50® Index fell -3.28%, while VSTOXX® spot rallied 34.61%. Between 3 March and 6 March equities attempted to rally, but could not break out of the drawdown and once again corrected from 6 March to 14 March EURO STOXX 50® Index 50 index fell -4.45%, while VSTOXX® spot rallied 30.27%. During the complete drawdown from 25 Feb to 14 March EURO STOXX 50® Index corrected -4.84% while VSTOXX® spot rallied 42.92%.

For an investor with European equity exposure (a hedger’s perspective), allocation to VSTOXX® during current market conditions offered diversification as the total losses of the EURO STOXX 50® Index corrections equated to -12%, while the VSTOXX® spot rallied in aggregate 88% during those corrections. When compared to the VIX spot index, it rallied 54% during those same corrections. However, more importantly during those corrections the VSTOXX® spot had an average correlation to the EURO STOXX 50® Index of -0.93 versus the VIX spot with an average correlation of -0.51. This would be similar to the historical performance of correlations relative to the EURO STOXX 50® Index. During these equity corrections, the average VSTOXX® spot returned 29% versus VIX returning 18%.

As we noted in my previous article, “Noisy short-term correlations in global volatility index futures: why trading one regional index futures market may not be enough,” VSTOXX® spot tends to maintain a consistent strong negative correlation to the EURO STOXX 50® Index and often becomes more negatively correlated during equity corrections.

Another factor for a hedger to consider is the roll yield. Because VSTOXX® Futures tend to normally maintain a contango forward curve, roll yields are usually negative.


Chart 2: VSTOXX® Futures forward curves at beginning and end of EURO STOXX 50® Index corrections between 15 January 2014 and 14 April 2014.
Source: Bloomberg data

Chart 2 demonstrates that the forward curve tends to shift into backwardation during moments of a rally, allowing a hedger to receive a positive roll yield during those moments causing an extra yield to the position or at least offsetting what would normally be a negative roll yield.

As mentioned in previous articles, VSTOXX® is a range bound product; it is often overbought when it reaches the mid 20’s price range. When it is overbought, it may offer a signal to an upside move in the equity market or at least a short-term change in direction in equities and a possible signal to close the long VSTOXX® Futures position, reduce the position or to go short volatility. From a trader’s perspective, these moments of volatility may offer opportunities for new or current VSTOXX® Futures positions. As noted in Chart 1 (with the dashed line), overbought periods were reached on 9 October, 2013; 3 February, 2014 and again 14 March, 2014. During those overbought moments in Chart 1equities began to rally.

Liquidity is always important for a trader and especially so in moments of increased uncertainty or volatility. In 2013 VSTOXX® Futures averaged daily volume of 28,397 contracts. From January 2014 thru 28 April, 2014 there were 22 days when daily volume surpassed 30,000 contracts. Most of those days occurred during moments of equity corrections or a day or two before or after the corrections. Two of those days (3 March, 2014 and 14 March, 2014) daily volume exceeded 100,000 contracts. It is interesting to point out that both of those days were at the bottom of two equity corrections. This data implies that at times of increased European equity volatility - there was an increased utilization of VSTOXX® Futures. Moments of increased volatility and uncertainty are often the most vital moments for liquidity.

Several points are summarized from these moments of negative volatility in the equity markets:

  1. At moments of unexpected equity corrections, VSTOXX® may offer portfolio diversification. This could entail either allocating a perpetual exposure to VSTOXX® Futures since investors do not have a crystal ball and by the very definition of “unexpected” it occurs when many investors are least expecting the volatility.
  2. Or the investor may be monitoring VSTOXX® Futures for moments to enter or add to a position as equity corrections occur.
  3. VSTOXX® spot volatility index offered greater portfolio diversification to the EURO STOXX 50® Index versus the VIX spot volatility index due to: a. Differentials of return streams b. VSTOXX® spot volatility index offered greater negative correlation during moments of the equity corrections of thecurrent situation.
  4. These moments of volatility may offer opportunities to a trader as VSTOXX® is a range bound product.
  5. Expanding volume at moments of increased volatility is beneficial to traders and hedgers.

In the article “Forward curves of European and U.S. volatility indices” we discussed how the forward curve of the VSTOXX® Futures may shift from a natural contango curve to a backwardation curve. The curve tends to be in contango when equity markets are rallying. This may occur as investors perceive a higher probability for future volatility versus the situation at that time. Backwardation occurs when equities are in a correction mode and VSTOXX® Futures tend to rally, therefore the market views a greater emphasis on a current equity correction than a correction in the future.

Chart 2 demonstrates how the VSTOXX® Futures curve shifted from contango to backwardation during EURO STOXX 50® Index corrections. The curves in the chart are labeled as dates of the peak with a “B” just before the correction began and an “E” at the trough or end of the market’s correction. The Y axis is VSTOXX® prices and the X axis are the spot, nearby and back month futures contracts.

The four curves at the bottom of the chart represent VSTOXX® Futures forward curves when the EURO STOXX 50® Index peaked, the day before the equity correction began. The curves are similar because they are in contango and the prices are in the teens.

The four curves at the top of the chart are similar because they represent the forward curves at the end of the equity corrections and are higher priced than the previous four curves, due to a rally in VSTOXX® Futures. All of the curves begin with the spot price in the 20’s and tend to be in backwardation for the first few expiration months. In the 2nd or 3rd month a kink is in the curve from which the prices tend to drift higher or at least flatten out.

The “15 April E” curve is the exception as it is in backwardation only in the first month and the rest of the curve is in its normal contango formation. It is also the lowest priced of the four ending curves.
VSTOXX® Futures front month and nearby months tend to offer greater price movement during rallies compared to the back months. From a trader’s view, these are potential opportunities. This is seen in the back months as the “B” and “E” curves tend to converge in price. As mentioned earlier VSTOXX® Futures is a range bound product, some of those opportunities occur as the market moves from the bottom of the range to the top of the range.

Conclusions from the shift of the curve in Chart 2:

  1. As found in past research, the VSTOXX® Futures curve tends to shift from contango to backwardation as it rallies. The equity corrections during current conditions experienced similar results.
  2. For a trader, the greater price movement in the front and nearby versus the back months of VSTOXX® Futures offers increased potential .
  3. For a hedger, the positive roll yield offers possible opportunities during moments of increased market volatility.

In summary, there is increased market volatility across Europe due to the current market conditions. As the EURO STOXX 50® Index experienced corrections, VSTOXX® Futures with its tendency for a strong negative correlation to the EURO STOXX 50® Index rallied on those corrections. In moments of unexpected volatility, allocation to VSTOXX® Futures may offer an added value of diversification to an investor’s portfolio. It may also offer investors or traders temporal opportunities when uncertainty and volatility are found in the equity markets. VSTOXX® Futures may offer increased liquidity for hedgers and traders at moments of increased volatility.

By Mark Shore, Founder

About Mark Shore

Mark Shore has more than 25 years of experience in the futures markets and managed futures, publishes research, consults on alternative investments and conducts educational workshops. His research is found at
Mr. Shore is also an Adjunct Professor at DePaul University's Kellstadt Graduate School of Business where he teaches a graduate level managed futures/ global macro course. He is board member of the Arditti Center for Risk Management at DePaul Univeristy. Mr. Shore is a frequent speaker at alternative investment events. He is a contributing writer for Eurex Exchange, Reuters HedgeWorld, the CBOE Futures Exchange (CFE) and Micro-Cap Review.
Prior to founding Shore Capital, Mr. Shore was Head of Risk for Octane Research Inc ($1.1 billion AUM) in NYC, where he was responsible for quantitative risk management analysis and due diligence of Fund of Funds. He chaired the Risk Management Committee and was a voting member of the Investment Committee.
Prior to joining Octane, he was the Chief Operating Officer of VK Capital Inc, a wholly owned Commodity Trading Advisor unit ($250 million AUM) of Morgan Stanley. Mr. Shore provided research and risk management expertise on portfolio construction, product development and business strategy. Mr. Shore graduated from DePaul University with a degree in Finance. He received his MBA from the University of Chicago.
Past performance is not necessarily indicative of future results. There is risk of loss when investing in futures and options. Futures can be a volatile and risky investment; only use appropriate risk capital; this investment is not for everyone. The opinions expressed are solely those of the author and are only for educational purposes. Please talk to your financial advisor before making any investment decisions.