Buyside Strategies EQD Research Volatility

CME Group To Enter The Listed Volatility Derivative Space

Aug 17, 2020

By Russell Rhoads,
head of research

The final quarter of 2020 will be the start of the last three months of a year that we will all remember (not fondly). Pending regulatory approval, it will also bring traders a new method of getting exposure to volatility expectations with the launch of futures on the Nasdaq-100 Volatility Index (VOLQ) in early October. VOLQ is a product created by Nations Indexes using NDX option prices to calculate expected 30-day volatility for the Nasdaq-100.

The methodology used to calculate VOLQ differs from the VIX methodology used to calculate the variety of volatility indices published by Cboe Group. VOLQ is calculated by using the first and second in-the-money and first and second out-of-the-money call and put options from four different expiration series. The series are the two just before and two just after the 30-day time frame. The result is a consistent measure of expected volatility calculated using pricing from 32 option contracts. The VIX methodology involves using two different expiring series, but practically all the actively quoted out-of-the-money options from the two relevant series.

Historical data for VOLQ stretches back over five years to the first day of 2014. Thecorrelation between daily VOLQ and NDX price changes is -0.725 over this time period which is in line with a correlation of -0.719 between VIX and the S&P 500 (SPX). The chart below shows the daily price changes for NDX and VOLQ for the first seven months of 2020.

VOLQ and VIX do share a positive relationship with the daily price change correlation between these two indexes at +0.821. If this sort of price activity carries over to the tradable futures it should create some spread trading opportunities between VIX and VOLQ futures. This second chart compares VOLQ and VIX daily pricing for the first seven months of 2020 including a depiction of the spread between the two.

The bottom section of the chart above shows VIX at a premium to VOLQ for a good portion of 2020, specifically from March to mid-July. Using the full historical record, VOLQ trades at a premium to VIX about 60% of trading days, so 2020 is a bit of an anomaly relative to the full historical relationship between VIX and VOLQ.

The introduction of VOLQ futures by CME is going to add another method of trading expected volatility for a broad-based stock market index. It also will offer an opportunity to trade the relative expectation for the S&P 500 and Nasdaq-100. But finally, this opens the door for the potential listing of VOLQ options, as option market makers would want futures available in order to quote and hedge VOLQ options. It may turn out the final quarter of 2020 gives volatility traders another reason to not completely write off 2020 as a year that was not so kind.