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VOLATILITY AS AN ASSET CLASS
JUNE 2012
Societe Generale Corporate & Investment Banking
Global Markets Division | CROSS-ASSET SOLUTIONS GROUP
Julien Lascar – Cross Asset Solutions
2
CONTENTS
VOLATILITY:
● WHAT IS IT?
● WHICH VOLATILITY?
● WHAT TO DO WITH IT?
TAIL HEDGING
● HOW TO TRADE VOLATILITY
● VIX IS THE BEST EQUITY VOLATILITY INDEX
● ACCESS TO VIX
● CASE STUDY
ALTERNATIVE INVESTMENT
● VOLATILITY PREMIUM
● ACCESS TO VOLATILITY PREMIUM
● CASE STUDY
2
VOLATILITY
WHAT IS IT?
● A MEASURE OF RISK
● Volatility most frequently refers to the standard
deviation of the continuously compounded returns of
a financial instrument with a specific time horizon. It
is often used to quantify the risk of the instrument
over the time period.
WHICH VOLATILITY?
● IMPLIED vs. REALIZED
● VOLATILITY IMPACTED BY TIME PERSPECTIVES
(MATURITY), LEVEL OF RISK (STRIKE/SMILE)
● EACH UNDERLYING HAS ITS OWN VOLATILITY
● MODELISED DIFFERENTLY
Bp/day for HJM model (Interest rate)
%/year for Black model (FX, Equity, Commo…)
WHAT TO DO WITH IT?
● CAPTURE OPPORTUNITIES
4
5
VOLATILITY
HEDGING: OPPORTUNITIES INVESTMENT: OPPORTUNITIES
5
WHAT TO DO WITH IT?
TAIL HEDGING ALTERNATIVE INVESTMENT
6
TAIL HEDGING
HOW TO TRADE VOLATILITY? VIX IS THE BEST EQUITY VOLATILITY INDEX
ACCESS TO VIX CASE STUDY
LISTED/OTC OPTIONS ON AN EQUITY INDEX
VARIANCE/VOLATILITY SWAPS
● Exchange of realized volatility at maturity with
a pre-determined fixed amount, The “Variance
Strike”.
● Spot Start, Forward Start.
VIX FUTURES
● The benchmark for stock market volatility,
measuring implied short-term volatility of S&P
500 Index options.
ETNs & ETFs
SYSTEMATIC FUNDS
TAIL HEDGING HOW TO TRADE VOLATILITY?
Liquidity
Roll Mgt
Bid-Offer Spd
Flexibility
Cost of Carry
Transparency
7
WHAT IS VIX ?
● The benchmark for stock market volatility,
measuring implied short-term volatility of S&P
500 Index options.
● Highly Transparent & Liquid – VIX futures
are exchanged traded on the CBOE.
● Tight Bid/Offer Spread – especially in
comparison to Vol and Variance swaps.
WHY VIX ?
● Negative Correlation with Equity Market
● When equity market are dropping, they all
move down
TAIL HEDGING VIX IS THE BEST PROXY
0%
50%
100%
150%
200%
250%
300%
350%
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
SPX Index HSI Index VIX Index
8
ROLL VIX FUTURE CONTRACTS
● But, the market is in contango most of the time
TAIL HEDGING ACCESS TO VIX – BASIC WAY
Time
Future
Price
! COST
OF
CARRY
9
SGI VI BETA INDEX – Calculated by S&P
The SGI VI Beta Index provides long implied volatility exposure through VIX futures.
The Index invests in the VIX futures contracts through a utility function, which aims to provide the best roll in
order to benefit from:
● The smallest carry cost1 of the contango term structure (low volatility regime).
● The highest positive carry earning of the backwardation term structure (high volatile regime).
The Index contains a dynamic exposure that leverages expo to VIX Futures when VIX is going in backwardation
The higher the volatility, the higher the exposure to the short-term futures contract.
High Transparency & Liquidity
10
Negative carry in
contango
markets
1Primarily invests from 1st to 6th contract
1/5th of positions are daily rolled.
Positive carry in
backwardation
markets
TAIL HEDGING ACCESS TO VIX – SMART WAY
CASE STUDY 1 - DIVERSIFIED PORTFOLIO (KOREA)
The increased allocation of the SGI VI Beta Index to the diversified portfolio shows enhanced
performance.
11
THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST
PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO
HISTORICAL MARKET DATA
Diversified Portfolio
KIS Govt Bonds 5Y+ (KISKGV5Y Index): 75%
Korean Equities (KOSPI2 Index): 20%
Commodities (DJUBS Index): 5%
Diversified Portfolio 95% x Diversified Portfolio
+ 5% SGI VI Beta
90% x Diversified Portfolio
+ 10% SGI VI Beta
Since 18 Jun 2007 (5 Year) 6.90% 8.80% 10.68%
Since 1 Sep 2008 (Financial Crisis) 9.23% 11.49% 13.72%
Since 14 Mar 2011 (Launch Date) 5.54% 7.39% 9.22%
Source: Bloomberg as of June 18th 2012
Annualised Return Comparison
0
100
200
300
400
500
600
700
90
100
110
120
130
140
150
160
170
180
Jun-2007 Jun-2008 Jun-2009 Jun-2010 Jun-2011 Jun-2012
Diversified Portfolio
90% Diversified Portfolio + 10% SGI VI Beta Index
95% Diversified Portfolio + 5% SGI VI Beta Index
SGI VI Beta Index
TAIL HEDGING
CASE STUDY 1 - DIVERSIFIED PORTFOLIO (HONG KONG)
The increased allocation of the SGI VI Beta Index to the diversified portfolio shows enhanced
performance.
12
THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST
PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO
HISTORICAL MARKET DATA
Diversified Portfolio
iBoxx ABF Hong Kong TR Index (ABTRHK Index): 75%
Hong Kong Equities (HSI Index): 20%
Commodities (DJUBS Index): 5%
Diversified Portfolio 95% x Diversified Portfolio
+ 5% SGI VI Beta
90% x Diversified Portfolio
+ 10% SGI VI Beta
Since 18 Jun 2007 (5 Year) 4.18% 6.18% 8.16%
Since 1 Sep 2008 (Financial Crisis) 2.98% 5.42% 7.85%
Since 14 Mar 2011 (Launch Date) 0.53% 4.53% 2.53%
Source: Bloomberg as of June 18th 2012
Annualised Return Comparison
0
100
200
300
400
500
600
700
90
100
110
120
130
140
150
160
Jun-2007 Jun-2008 Jun-2009 Jun-2010 Jun-2011 Jun-2012
Diversified Portfolio
90% Diversified Portfolio + 10% SGI VI Beta Index
95% Diversified Portfolio + 5% SGI VI Beta Index
SGI VI Beta Index
TAIL HEDGING
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
The observed difference between implied and realized volatility is called the volatility risk
premium
● In option markets, price inefficiencies exist due to a structural imbalance between volatility buyers and sellers.
● Market participants - generally large institutions – are mainly hedgers and have to buy at a premium to attract
capital into the derivative market.
Average
4.8% / y
Average 1-month historical daily
volatility risk premium between VIX
and S&P 500
Source: Bloomberg, from 02/01/1990 to 15/03/2010
THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST
PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS.
ALTERNATIVE INVESTMENT VOLATILITY PREMIUM: IMPLIED VS. REALIZED
14
BASIC WAY: SHORT VARIANCE SWAP
● VARIANCE SWAPS ARE FORWARD CONTRACTS ON THE REALIZED SAMPLE VARIANCE OF RETURNS
OF AN UNDERLYING ASSET.
● THEY PROVIDE A LINEAR PAYOFF THAT IS A FUNCTION OF THE SAMPLE VARIANCE OVER THE
CONTRACT LIFE.
ALTERNATIVE INVESTMENT CAPTURE THE VOLATILITY PREMIUM – BASIC WAY
Can be easily customised
Advantages
Higher bid-offers
Less liquid, as OTC
Disadvantages
LONG LEG:
IMPLIED VOLATILITY
SHORT LEG:
REALIZED VOLATILITY
15
SGI VOL PREMIUM DYNAMIC 2 INDEX
1. Trend Indicator
● “Trend indicator” to determine the position on the variance
swaps Long or Short?
● The Trend Indicator is a dynamic mechanism that looks at
different market parameters
short term realized volatility of S&P 500 Index
change in VIX
the observed volatility premium
2. Taking a Long/Short Position
● Positions taken each day in 1-month variance swaps, on a
fraction of the index value.
● The index is computed on a daily basis using mark-to-market
levels of the variance swaps.
16
The figures used in this example are given for purely indicative purposes, the objective is to describe the
mechanism of the product. It allows an understanding of how the product would have performed at different
market stages over previous years, but is no guarantee as to future returns and has no contractual value
Trend Indicator
Short position in 1M
Variance Swaps
(40% leverage)
Long position in
1M Variance Swaps
(10% leverage)
If positive
If negative
Short
Long
Trend Indicator
Short position allows to capture the spread between implied and realized volatility on the S&P 500 Index. Long position enables to quickly offset the risk of a short realized volatility exposure in volatile markets.
Seller of variance swap
Buyer of variance swap
Buyer pays the swap strike
ALTERNATIVE INVESTMENT CAPTURE THE VOLATILITY PREMIUM – SMART WAY (1)
3. Dynamic Exposure
● The dynamic exposure mechanism makes it possible to deleverage more quickly in case of a sudden rise of volatility
(40% leverage for a short position and 10% leverage for a long position).
● The Index tracks the performance of a variance swap’ portfolio¹.
17
The figures used in this example are given for purely indicative purposes, the objective is to describe the mechanism
of the product. It allows an understanding of how the product would have performed at different market stages over
previous years, but is no guarantee as to future returns and has no contractual value
1The portfolio is usually made up of around 21 short or long positions, corresponding to the number of business days during the month.
2 Computed one day before
3 Number of business days corresponding to 30 calendar days since the launch of the previous variance swap (Trend Indicator is the
one observed for the week, not necessarily on that day)
ALTERNATIVE INVESTMENT CAPTURE THE VOLATILITY PREMIUM – SMART WAY (2)
SGI VOL PREMIUM DYNAMIC 2 INDEX
18
THE FIGURES RELATING TO PAST PERFORMANCES AND SIMULATED PERFORMANCES REFER TO PAST PERIODS
AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA
Source: Bloomberg as of June 18th 2012
50
100
150
200
250
300
350
Jan-1999 Jan-2003 Jan-2007 Jan-2011
SGI Vol Premium Dynamic 2 Index S&P500 Index
SGI Vol Premium Dynamic 2
1Y 0.04%
5Y 7.48%
Since Launch
(14 Mar, 2011) 4.02%
Volatility (5Y) 9.74%
Sharpe 0.77
Source: Bloomberg as of June 18th 2012
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The SGI VI Beta Index (The “Index”) is the sole and exclusive property of Société Générale (“SG”). SG has contracted with Standard & Poor’s (“S&P”) to maintain and
calculate the Index. S&P shall have no liability for errors or omissions in calculating the Index. The VIX® is the property of the Chicago Board Options Exchange,
Incorporated. The VIX ® Index has been licensed for use by SG in connection with the Index.
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maintain and calculate the Index. The S&P 500® Total Return index is the exclusive property of S&P and the CBOE Volatility Index® (the VIX®) is the property of the
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shall have no liability for any errors or omissions in calculating the Index.
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Bloomberg Page: SGIX
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IMPORTANT INFORMATION
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