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This article first appeared in EQDerivatives' subscription Commentary & News service.
Investors in the U.S. are looking at transactions that play the VSTOXX® and Chicago Board Options Exchange Volatility Index spread in a bid to trade the effects of the Greek crisis.
A tail risk specialist at an asset manager in New York noted the spread between the VSTOXX® and the VIX had been widening for some time. “We identified that there’s generally a band in which these trade and VSTOXX® a few months ago had been fairly tight relative to the VIX,” he said. “And now that’s moved quite a lot, so there are a lot of opportunities for that in terms of skew strategies.”
Greek authorities restricted bank opening times Monday in a bid to limit a run on savings accounts as fear spreads of a default on the country’s debts. Greece’s E.U.-sponsored bailout expires Tuesday, the same day a EUR 1.6 billion International Monetary Fund payment is due. Talks between the Greek government and the E.U. broke down over the weekend, with Greece pushing for a referendum before agreeing to any further negotiations.
The instability saw the VIX jump to about 18.85 from 14.02 on Monday, while the VSTOXX was trading about 14% higher to 30.65, giving a 16 spread. According to VSTOXX®, the VIX/VSTOXX® spread typically averages about 4.14 with a standard deviation of 4.25.
“Two and three standard deviations would price the spread at 12.60 and 16.83 to the upside,” according to a research report from Eurex. On the downside this would price the spread at -4.32 and -8.54, the Spreading European and U.S. Volatility Index Futures report noted. “If you only calculate the positive spread days, the average is 4.87 points with standard deviation of 3.87. About 58% of the time the VSTOXX®/VIX spread trades between zero and five. When the spread reaches the eight-to 10 point range, it may be considered overbought. About 14% of the time, the spread is priced above eight.”
In a client note today, strategists at Société Générale suggested investors buy VSTOXX®/VIX five-month future spread, rolling the position every four months. “The downward sloping VSTOXX® term structure combined with the steep contango of the VIX curve make the long term VSTOXX®/VIX Future spread very attractive in terms of carry,” the strategists said.
They added European medium-term implied volatility is under pressure due to Korean Autocallable structured product supply, while realized volatility remains significantly higher in Europe. “Five-month rolled every four months seems to be the best way to extract value from the inverted term structure [since 2009], especially when roll bid-offers are included: This systematic strategy was very profitable between 2009 and 2013 and has started to perform well again with current contango since the end of 2014.”
The tail risk specialist noted, while the VIX may have been a decent hedge during past instances of European volatility, it has been spiking less with each instance of instability. “This would be more of a timing sort of play, as in the VIX doing better than the VSTOXX®,” he said. “Today the market sold off a bit, but at the same time if you see VIX come below 13 then it does become pretty attractive.”
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