The first FX VolContracts offered for trading will be based on the volatility between the euro and the U.S. dollar. The contracts are:
FX Realized Volatility futures, called FX VolContracts, are the first futures contracts that offer direct trading of FX volatility. FX VolContracts allow participants to buy or sell FX volatility without the complexity of managing standard options positions, and without the necessity of forming a strong directional view on the underlying.
The contracts are offered under a license agreement with VolX, the Volatility Exchange Corporation. For additional information on VolX, please visit www.volx.us.
To date, volatility-related instruments trading on regulated exchanges have settled to implied, not realized, volatility. Direct trading on realized volatility has occurred typically only in large sizes in the over-the-counter market or by trading listed options and “delta-hedging” them, a dynamic, costly, and time-intensive process. Trading VolContracts based on foreign exchange will change that process to a straightforward, inexpensive buy/sell decision, as well as improve market transparency and price discovery.
FX VolContracts will be cash-settled to either a 1- or 3-month historical or “realized” volatility calculated by reference to daily price movements in major CME currency futures. The realized volatility calculation is based on a simple standard deviation formula. The description for this formula can be viewed here. The contracts are valued at $1,000 x the computed realized volatility for the specific time period. They are quoted as an annualized standard deviation in minimum increments of 0.01%. (i.e. One may quote the contract as 12.52; 12.53; 12.54, 12.55, 12.56, etc.)
If the contract is quoted at 12.52, this implies a nominal contract value of $12,520 (= $1,000 x 12.52). If the contract value fluctuates by one minimum price increment of 0.01 (i.e.., from 12.52 to 12.53), this implies a fluctuation increase of $10.00 in the contract value. These contracts will be listed on CME Globex.
View Contract Specifications for Quarterly FX VolContracts (3-month FX Realized Volatility Futures)
View Contract Specifications for Monthly FX VolContracts (1-month FX Realized Volatility Futures)
Volatility of the underlying instrument is a key input into options pricing models and a necessary component of any successful options trading strategy. CME Group trades American-style options on futures for 25 currency pairs. For six of these pairs, CME Group also lists European-style options on futures which include: EUR/USD, GBP/USD, CAD/USD, JPY/USD, CHF/USD and AUD/USD.
There are a variety of alternate methodologies for calculating volatility. Realized standard deviation, sometimes referred to as historical deviation, along with variance (standard deviation squared) are two measures of volatility. Or, one may utilize an index or amalgamation of implied volatilities derived from observed option premiums.
Standard Deviation vs. Variance - A realized variance has some desirable mathematical properties that render it attractive to some OTC traders. Specifically, one may derive a linear relationship between variance and option values, facilitating hedging activity. However, variance may also be very unstable. For example, consider that if standard deviation moves from 10% to 20%, this implies an exponentially exaggerated movement from 100 to 400 in variance. For this reason, standard deviations are more frequently quoted and more intuitively appealing.
Implied Volatility - Alternatively, one may construct an average or amalgam of implied volatilities, “IV”, associated with available option markets. The most popular average of this nature is, of course, the VIX. But controversies may arise regarding the sampling and weighting of various option IVs in the average.
Quarterly/Monthly Realized Volatility - Thus, CME Group has developed quarterly and monthly realized historical volatilities of its most popular currency futures contracts, the majors: EUR/USD, GBP/USD, CAD/USD, JPY/USD, CHF/USD and AUD/USD, which can be viewed at www.cmegroup.com/fxrealizedvol.
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