Since 2005, VSTOXX®[1] has measured expectations for volatility in the EURO STOXX 50® benchmark — an essential gauge of the Eurozone’s “market fear.”
The VSTOXX indices track real-time options prices on the EURO STOXX 50, thus reflecting market expectations of future volatility – also known as implied volatility – in Eurozone stocks. Although the main VSTOXX 30 days index (STOXX ticker V2TX) is the most popular – and is usually referred to as “the VSTOXX” – eleven other indices are calculated, covering fixed maturities up to 360 days in increments of 30 days.
A new STOXX whitepaper from Hamish Seegopaul, Global Head of Index Product Innovation, and Thomas Shuttlewood, Associate Vice President for Product Research and Development, takes a comprehensive and in-depth look at the objective, methodology, coverage and calculation of the indices in the most complete study from STOXX on the topic to date. The paper is an excellent opportunity to get introduced to, or revisit, the VSTOXX and the concepts of volatility and volatility trading.
Methodology
The VSTOXX recreates at each calculation interval a portfolio of out-of-the-money options that represents the implied variance of the EURO STOXX 50. The square root of this is the implied volatility. VSTOXX covers all EURO STOXX 50 options listed on Eurex with a given time to expiration, assuming that these meet certain pricing criteria.
The STOXX study walks readers through the various steps of the VSTOXX methodology, including the core formula, options price screening, options weights, the determination and selection of the at-the-money strike price, and finally the variance and subindex calculation.
Trading strategies
As Hamish and Thomas note, volatility has become an asset class in itself and accessible for the average investor thanks to the rich ecosystem of listed, tradable products tracking the VSTOXX indices.
These days, those products help implement trading strategies including directional views, volatility selling, dispersion trading and hedging. Traders and investors also use the VSTOXX as a “market fear gauge” and as a determinant to trigger specific trading strategies.
STOXX has also introduced volatility trading indices to support the implementation of some of those strategies. These indices include the EURO STOXX 50® Volatility (VSTOXX®) Short-Term Futures, VSTOXX® Short-Term Futures Investable and the EURO STOXX 50® Volatility-Balanced. Investors can also resort to the VDAX®, which measures the volatility of the German equity market based on options on the benchmark DAX®.
“The VSTOXX index and the ecosystem of derivatives based on it enable market participants to express views on European volatility, establish carry trades, hedge positions and determine which market regimes might offer optimal positioning,” the authors write.
Characteristics of volatility
The whitepaper’s authors also explore three unique behavioral characteristics of volatility: its tendencies to revert to the mean, to be negatively correlated with its underlying asset and to cluster in regimes. These trends have also led to volatility’s acceptance as a separate asset class and can be substantiated by analysis presented in the study.
We invite you to download the whitepaper and understand the intricacies of VSTOXX and volatility trading.
[1] Full name: EURO STOXX 50® Volatility index.