Recording in progress.
S&P 500 variance futures, slated to begin trading in September on September 23 of this year, just in time for the election, which is shaping up to be another exciting one. To talk about our new product, we have with us today John Hiatt from our Cboe Labs team. That's the team behind basically all the new products that's coming out, the brains behind the operation, I like to say. But in addition to John, who's gonna give an overview of the product, we're really also excited to bring you kind of the a more complete perspective of of the whole ecosystem that's gonna be trading and also supporting this product from a liquidity standpoint. So with me today, also, we have Alexis Lefebvre , who is the CIO, Co-founder, and Portfolio Manager at Melqart Asset Management, a U.K.-based hedge fund.
We have Nick Wolby , who is the Head of Equity Derivative Index Trading at Morgan Stanley, as well as Tom Seewald , COO at Akuna Capital, who's gonna be one of the market makers supporting this product. So very excited to have everyone here. And then kind of a matter of housekeeping, we're gonna go through some prepared content, prepared moderated discussion. There will definitely be time for Q&A. We're, you know, very excited for Q&A. So to ask a question, there should be a Q&A box or a button icon at the bottom of your Zoom toolbar. So feel free to enter questions at any point during the presentation, and then toward the end, we're gonna get to the Q&A section.
In terms of timing, this will be a 30-minute webinar, so 20 minutes, roughly, of prepared content and 10 minutes of Q&A. So without further ado, I'm gonna turn it over to John. John, would you, could you walk us through kind of just, again, overview, given the time constraints of this, new product?
Sure. Thanks, Mandy. Good morning, everyone. So as Mandy mentioned, subject to regulatory review, on September 23rd of this year, we plan to launch cash-settled futures on the realized variance of the S&P 500. If you see on the first slide here, you'll see a formula for the final settlement value of the contract, labeled Fₛ. And basically, what we're settling to is the annualized sum of the squared returns of the S&P 500 daily returns of the S&P 500. The contract is going to trade in variance units and be quoted in terms of the variance of the S&P 500. So, a price of 400 would mean an implied volatility of 20% on the first day that the contract is listed.
The contract size, as I mentioned, is one variance unit, and it trades in variance units, so it'll clear immediately, which is somewhat different than our previous version of variance futures that we launched in 2012, and traded from 2012 to 2022. If you see on the upper right of the first slide that we have here, these are the contract months that are gonna be launched on September 23. So basically, we'll have the first six months of contracts and then a contract expiring in June 2025 and December 2025. Each of the contracts will begin accruing realized variance on the date that it's listed, with the very first return or very first price observation.
That is, the close at the, on the day that the contract is listed. And then you'll just sum the close-to-close returns, for all of the days, except for the final day. The final price observation will be the opening settlement value of the S&P 500 on it, the contract's expiration date. That's the same value that we use to settle SPX options on that date. So you'll have a string of returns, that you'll square to find the final settlement value, which are closing returns, based on closing returns, and then the final return will be based on the previous night's close and then on the final settlement value. So if you look at that contract table, if we start on September 23rd, that first contract that expires on October 18th, will settle to approximately one month of realized variance.
The November will settle to 2 months, and so on, through the March contract, which will be 6 months of realized variance. The June and the December contracts are a little bit more. The June contract will settle the 9 months of realized variance, and the December, just over a year. The only other thing that I'd point out on the first slide is the idea of market disruption dates. So if it's the case that you had something like the National Day of Mourning for a deceased president, and that happens during any of these contracts, the way the contract functions is that that date will be considered a zero variance day, so we're not accruing any variance on a disruption event.
So the number of returns required to compute the final settlement is, it's set, established at the start of the contract and really doesn't change when a market disruption event occurs. Mandy, you can go on to the second slide. So you have the final settlement is just the sum of the squared returns of the S&P 500. Daily settlement values for the contract are going to be a combination of the realized variance that's accrued to the date that you're on, plus what's implied for the remainder of the contract. That's pretty much how the contract will trade throughout the trading day as well.
There's one other thing to note about it, is that on the day that you enter a trade in the contract, you have exposure to the S&P 500 index level at the time that you make that trade. So if you were thinking about the price of the contract intraday as you're trading it, it would be a combination of three terms: the accrued realized variance to the previous night's close, and then the variance of that close, previous night's close, to when you're trading the contract. So you have exposure to the S&P 500, and then you have another term, that's the implied variance for the remainder of the contract. You could advance the slide again, Mandy.
As I noted, we're going to be trading in variance units, so you can think of the vega exposure of one variance unit according to the formula that you see on this page, and it's just two times the implied volatility of the contract, and then you're multiplying it by how much of the contract is remaining, or the distance, or days to expiration, basically. If you were thinking that you wanted, say, 100,000 vega in exposure, you would just divide 100,000 vega by the term that you see there to figure out how many contracts you needed to trade.
So if I were saying that it's the first day of trading and we were quoting an implied volatility of 20, which would be, 400 on the variance futures price, you would divide 100,000 vega by 40 to come up with your number of variance units, and you would get about 2,500 contracts that you would need to trade. You can advance the slide again, Mandy. So when the contract is live and we begin trading, this site isn't up yet. We have a certification test before we launch the contract that starts next Monday, and there'll be a link on our resource hub, where you can see this variance calculator.
Basically, what this is meant to do is allow you to convert the futures price that you'll see in the two-sided market while you're trading the contract into an implied volatility, in the first box here. And then you can also go back from an implied volatility to what the futures price would be. Or you could convert your vega notional that you want to trade into an order size or a number of variance contracts that you need to do.
Another thing that's nice about the variance calculator is that if you look near the contract expiration, the dropdown for which contract you're trading, you can download the contract schedule, which will give you what's the accrued variance to date, how many days of realized variance are you actually going to settle to, how far through the contract you are, so that you can do all of the conversions between vol and vega and the number of futures and a futures price. You could advance the slide. The next slide is just the resource hub that we have up today. You could link to the site. As I mentioned, if you look under the Resources tab on there, you'll see the Variance Calculator once we get into cert next week.
You can see the contract specs that we filed to trade the contract and any questions, including what you'll see on Cboe data feeds for the contract, in terms of accrued variance to... and the number of date days of accrued variance that we'll be settling to the contract.
Great. Thanks, John. I'm going to leave this slide up for a little bit longer so that if people want to, you know, copy down the link. The slide deck itself will also be available after the webinar. But maybe another question to you, John, and you mentioned, you know, this is not our first time launching variance futures. So, you know, just to kind of, you know, I wanted to know, what's been the customer feedback this time around, and, you know, what's different about this launch versus prior iterations that make you more confident that, you know, it'll be successful?
Sure. So, this is actually the third time that we've tried to launch a future that settles to the realized variance of the S&P 500. The original contract we did was back in 2004, and when we did that, every contract settled to three months of realized variance of the S&P 500, and the contract expiration's tied to the March quarterly cycle. It was quoted in variance, number of variance, futures, variance units, and, and a variance price as well. Then back in 2012, some of the feedback that we had gotten on that contract was it was difficult to go from an implied volatility and a vega notional exposure, which is typically how the contract is traded in the over-the-counter market, to what we were quoting, variance futures and, variance futures price.
And so our second version of the contract, we actually did some development work, so we could allow the contract to trade in terms of a spot starting implied volatility and a vega notional exposure. That required many of the market participants that would trade and clear the product to do development work themselves in order to trade it, because we would pend a trade until the end of the trading day, so that we could observe that day's S&P 500 closing price, so that we can convert from a variance futures price, a number of contracts into-
... we convert the implied vol into a number, a variance futures price and the vega notional into a number of contracts. So this time around, I think what's really different in how the market has changed is, you know, there's been some changes to uncleared margin rules that have affected the viability of trading variance in the over-the-counter market. So there are people who are looking for an exchange solution this time, and it's the case that most of the people that have contacted us and wanted to trade variance in a listed environment would prefer not to trade it the way that we have it today in variance futures prices, and a number of variance units, simply because then you don't have to do the development work that was present in the second contract.
Got it. Super helpful. Okay, so I'm gonna now turn the conversation or open up the conversation to our other panelists, and Alexis, I'm gonna go to you first. Can you just talk to us about how, you know, what instruments are you currently using to trade vol, and what's your kind of been your experience trading, in particular, variance over the past couple of years, maybe pre versus, you know, post-pandemic?
Sure. So we actually trade vol through variance swaps, which are OTC and listed options, S&P and E-minis and VIX options, as well. So, you know, for us, internally, all of this is tied up together in our system and everything else, and we kind of look at it as a whole. However, in reality, you know, variance swap is OTC, and for a lot of kind of systems and institution, VIX is actually a different asset than S&P. So in terms of risk aggregation and margining and all this stuff, like, it's not really tied up together. So variance swaps actually trade at OTC, causes a certain amount of issues.
So the first one is that, you know, we need these tests for every counterparty that we trade with, and also, you know, we will have, you know, VIX in listed format and variance swap in OTC formats, which might sit at different places. So first, there's an ISDA, second, there's you know, instruments at different places. The second issue, I think, for us, has been valuation. So at the moment, you can either use market or you can use counterparty marks, but I can trade, you know, the same variance swap with two people and have two different marks. So in terms of valuation, it's not ideal, and you can rely on market, but that causes other issues. I think the last thing that I think will be beneficial in having this kind of listed product is, you know, the actors.
I think, you know, banks have been in and out of the market, depending on appetite, especially with, you know, issues that have been caused by, you know, previous kind of fund defaults, where the ISDA was very big, and that reduces a lot of capacity to trade. Now, with the listed contract, we will have access to not only banks, but kind of professional market makers and, and possibly a wider universe than that going forward. So it's liquidity, it's, you know, kind of counterparty sets and really valuation that, that, that would change for us.
Great. I think you already touched upon a lot of the points that I'm gonna ask in the second question, so maybe just to recap, I was gonna ask you what's most enticing about this product? But I think you talked a little bit about, you know, the liquidity and the transparency. Maybe just, you know, what's top of mind in terms of, you know, what appeals to you the most about this upcoming launch?
Yeah, and I think there's also gonna be, you know, more granularity down the line. I think if you take the template of, really, sorry, what VIX has been, it started with a few contracts, and then, you know, now we're at the point where there's contracts every day, and then there's a possibility of have, like, VIX intraday. So I think at this point, you know, if the product takes off and it all works well, we'll be able to trade variance, but also forward variance, so we'll be able to trade each day completely individually. So that actually really pushes our ability to trade event risk without having to spread it.
So if you look at, you know, 6-12 months down the line, if it's successful, there's actually a lot more possibilities for us to be more nimble-
Got it.
Then we're now.
Very helpful. Okay, next, I want to turn over to Nick, who's gonna be one of the sell-side, trading desks, so hopefully, active in this product once we launch. So Nick, you know, can you just give us an overview, maybe of kind of which client segments are currently active in trading variance, and just how that market has changed, again, now versus, say, pre-COVID?
Sure. I'd say it's a very wide client segment, ranging from hedge funds to asset managers to pension funds, pension funds and insurance companies. I'm definitely excited about the prospect of being able to provide block pricing on these variance futures. I think anybody who traffics in the VIX futures and VIX options market should be thinking about the benefits of being able to express directional views in volatility with direct exposure, realized vol in a listed instrument. The potential user base for the product is wide.
I do expect initial interest to come from the existing OTC variance swap market participants, looking for lower margin and collateral alternatives to OTC variance swaps, and, you know, as Alex has mentioned, some of the transparency that you get from the listed market, that you know, you sometimes don't get with OTC, with people having different valuations.
... I think with the liquidity and volumes in the S&P listed options market, in the VIX futures market, and the VIX options market, S&P variance futures are an obvious missing link in the listed S&P vol complex, given the arbitrage relationships that exist amongst these. So the product's gonna naturally fit into the complex. And I think it's not only gonna satisfy existing demand, but it's also gonna allow for the development and growth of other products that can utilize listed variance futures as a vehicle for expressing directional views on realized volatility, without the path dependency of option-based expressions. In terms of what's changed now versus pre-COVID, it's definitely. I think it's interesting that there's been huge growth in the listed options market, especially in the S&P vol complex.
But we've actually seen probably the OTC variance swap market, which had been roughly active for two decades. It's actually probably as small as it's been over those last two decades as a result of the increased margin and collateral requirements. So I think this listed alternative comes at a really appropriate time.
Great. And then maybe just a follow-up. Who kind of-- who would, would you, who do you see as being kind of the biggest beneficiaries of having a listed product? 'Cause you mentioned, you know, existing vol players kind of being the day one users, but, you know, any other kind of beneficiaries that you see from this, from this product?
Yeah, I mean, I think, certainly the vol arb community on the hedge fund side, which has grown in size, is going to be the most active participant. And I think for them, as being really active, in turnover, this is going to be a very beneficial product, especially with the cross-margining benefits that you'll get, from the, you know, across the rest of the listed S&P vol complex. So anybody who's trafficking in that complex and really trafficking with a bent toward thinking about the world from an implied volatility perspective, and that universe has certainly grown, I think is gonna be a natural beneficiary of this. And, and, you know, there, there's certainly been a gravitation over the last 15 years, I would say, from moving away from OTC products and toward listed products.
We've seen this happen in a variety of different instruments, and the success has definitely been pretty substantial.
Great, thanks. Okay, Tom, I want to turn over to you now. I know you were very active trading the prior version of variance futures that we listed, way back. So I guess my question to you is, what are you kind of looking forward to this time, kind of based on your prior experience? What, you know, what's different this time, in your view, that would make it a successful product?
So I think, you know, I was involved in, I guess, what John Hiatt referred to as the second iteration of this, about a decade ago. And at that time, as John mentioned, the focus was really on mimicking what was already trading over-the-counter, to make it as easy as possible for those really professional users, those sell-side desks, to migrate over to, yeah, a listed product. What that did was introduce a bunch of operational convexity that really cut out a lot of people who might otherwise have wanted to use the product. They weren't familiar with the OTC conventions, required a lot of development work. It was not easy for clearing firms to support these, and as such, the momentum when we relaunched the product in 2012, died out pretty quickly.
I think this time around, having a much simpler back office, middle office clearing equation of being able to print the trade at the time that you trade it, not having to restate it, is gonna be pretty substantial. It means it can trade like any other future. Also excited that it's designed to be accessible to anyone, not just, you know, vol arb funds, not just to big buy side or sell side desks. But, the variance units in which you can trade are relatively small and make it sort of inherently accessible to retail. You know, you pointed out the variance futures calculator on the variance hub, which will, you know, like you said, be live at some point soon.
Be very easy for anyone to go and figure out what they want to trade and execute right away. So operationally, I think a lot of the hurdles that prevented success when I was involved with this a decade ago have really cleared up and should really enable this product to, you know, as they say, third time should be the charm here.
Great. Yeah, and then I can tell you that anecdotally, that's definitely been some of the feedback that we've been getting, you know, from funds, for example, like CTAs and others who traditionally have not been able to access this market in the OTC format. They now can with the futures, you know, contract. They're very excited to get involved as well. My last question would be, you know, for you, Tom, kind of what opportunities, you know, does this give market makers, you know, who are currently not active in the OTC market for variance?
Yeah, that's a great question. I think the sort of distribution of liquidity provision over the last 15 years has really shifted away from, really only being available from big banks, big institutions, to being more diversified to principal trading firms and, and such. And I think that the... If you look at who some of the biggest options market makers are in both the, SPX complex, the VIX complex, you know, these days are large proprietary, or principal trading firms who may not have access to, the same range of ISDA that, large banks do. And the result is that the full depth of liquidity provision, is not available to the user of an OTC variance product. I think what you'll find here is that-
... of course, market makers, and, you know, there are dozens of active market makers in the SPX complex, who could easily provide liquidity here. But you'll also find just natural liquidity provision as well as smaller participants are able to access a central, you know, limit order book for these to post orders, not even two-sided quotes, but just to provide bits of liquidity here and there, which, you know, really add up, as we know. So, I think market makers are, you know, professional market makers, principal trading firms, are much more sophisticated than they were a decade ago. And I think it makes sense to have the largest liquidity providers in options also be able to provide that liquidity in listed futures as well.
Great. Thanks. Okay, so I'm seeing a ton of questions coming through, so great. Please keep sending those questions in. The first question I'm gonna throw to you, Alexis, because I know you have a hard cutoff at 9. The question is: From buy-side perspective, what are some examples of applications or use cases that are available with variance swaps or variance futures that are not available via VIX futures and VIX options?
I think as you pointed out earlier, the big difference is realized for one thing, and the second thing is that, you know, vol is linear and variance is convex. So if you really wanna trade, you know, that convex payoff, and especially for, you know, tail strategies, you need to have, one, to realize and, two, really the convex payout. So it kind of allows you to have one, the gamma, and two, the convexity.
If you think about it, one of the structures that, you know, is popular in other asset classes like FX, which is to trade pure complexity, i.e., variance swap versus vol swap, you know, now you can kind of trade a VIX future versus a variance swap future, and that will give you vega neutral or theta neutral, and that will give you that complexity. So that is, you know, available in OTC format, but it's not really available. You can't trade the convex products in the listed manner. So even in, you know, QIS product that cover a lot of the variance, like some short vol products, et cetera, variance is always replication.
So that's, you know, hundreds and hundreds of option contracts, and that makes it pretty difficult in terms of, you know, operationally and to kind of hold in your books versus one contract that's gonna do exactly the same thing and includes the basis at the end of the day. So really, the difference is gonna be gamma and complexity.
Great, thanks. A couple of questions are gonna combine into one, for John, and asking about kind of future iterations or, how this product may evolve. So, should we expect to see options on these futures at some point? Will there be longer-dated, you know, maturities, listed? And then another one is, is there any intention to launch a Russell 2000 variance future?
Sure. I think all three of them kind of depend on how well we do with the initial listing that we have. If we see good volumes in it, of course we'll increase the expirations. We have the ability for our rules to match all of the expirations that we have for SPX options today. So the December LEAPS go out five years, so you can imagine a contract that would list and settle to five years of realized variance of the S&P 500. Options on variance are certainly something that would be contemplated, assuming that we have you know, very good quoting and a lot of volume in the variance futures themselves, and extending it to other index providers that are partners of Cboe. Of course, we trade Russell, VIX options today, so...
Or Russell options today, so you could expect that we would try and trade a future on Russell variance, variance as well.
Great. One question, and I'm gonna maybe throw this to Nick first. Is it expected that the availability of these listed variance futures will dampen appetite for traditional OTC variance swaps? And what would the impact be on businesses that structure those?
Yeah, I, I think that remains to be seen. I think in my experience, when you have listed alternatives, you continue to have market participants that look for OTC alternatives, because there's definitely use cases for wanting to do OTC trades. There's benefit, of the you know, the anonymity aspect, the not being able for people, for people to see large trades that are going through in the market. And if you're trying to do outsized trades, I think there will continue to be clients that will gravitate toward OTC, for those types of situations. But there's clear benefits as well for people that are trafficking in, you know, standard size, higher turnover for using listed.
So I think the two can coexist, and it can probably be mutually beneficial to both ecosystems, to have both a healthy listed market as well as an OTC market. And we've seen that in S&P listed options as well as every other listed options product. So I think the same will be likely true for variance swaps as well.
Yeah, and I would, I would agree, and that's certainly our hope, too, is that, you know, this kind of helps grow the pie and bring in more players and, more investor types into this product, into the space, right? So it's not just taking share away from the OTC, but actually, you know, brings more liquidity providers, bring more end users, different fund types, people who are not currently able to access the OTC market, who want to trade vol. I think there is a large number of those end users. So that's what we're excited about. I think we're running pretty much on time, but maybe one last question, 'cause I, I do see it pop up quite a bit, and it is...
I don't know how quick we can be in the answer, but for John, what are the cross-margining arrangements or benefits, especially against VIX futures? Got a couple of questions around the cross-margining benefits.
Sure. So it's the case that, at least for clearing members at OCC, there would be cross-margin or portfolio margin available between VIX futures and options, SPX options and variance futures. There's a cross-margin agreement between OCC and the CME for SPX options and E-mini futures. VIX and variance futures aren't part of that agreement yet. I can't really speak to how an FCM will margin variance and VIX with SPX, but-
Yeah.
It's certainly the case for clearing members that it's available at OCC.
Great. Okay. So in the interest of time, I'm gonna have to cut it off here, but thanks for everyone for dialing in. As you know, John mentioned, we have a resource hub online already with contract specs, user guide for the calculator, and the calculator should be live, you know, by next week, hopefully. And then, you know, if you're interested in trading and being active in this product day one, please reach out to your liquidity providers, trading desk, as well as reach out to us if we can be of any assistance. And thanks again to all of our speakers. Really appreciate your time, and I'll see you guys next for next month's webinar.