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Volatility-Quoted Options Trading

Volatility-quoted options transact as follows:

  1. The client system submits an order to CME Globex, specifying the volatility-quoted option, as opposed to the standard premium-quoted option.
  2. The order will specify the volatility to trade the option rather than its premium.
  3. The order matches at the submitted volatility.
  4. CME Globex will send the client system three iLink Execution Report - Fill messages as follows:
    • Execution Report - Fill for the volatility-quoted option
    • Execution Report - Fill for the premium-quoted option
    • Execution Report - Fill for the underlying future

The Execution Report - Fill message for the premium-quoted option specifies the volatility price for the option and its equivalent in premium terms, calculated by CME Globex using standard option pricing models.

Volatility-Quoted Options Markets

Volatility-quoted markets are separate from premium-quoted markets. volatility-quoted options are bid and offered in terms of annualized implied volatility to two decimal places and in 0.01 increments (e.g. volatility percentage values of 7.15%, 8.02%, 12.48%).

The order book for any given strike price will be represented by quantity and volatility as shown below.

900 Call / Currency Option

Quantity

Volatility Bid %

Volatility Ask %

Quantity

90

8.15

8.17

100

50

8.12

8.20

50

20

8.10

8.22

20

Bjerksund and Stensland (1993a) Approximation Model

 Expand for the Complete Formula

Assumptions:

  1. Volatility quotes incoming from Market Maker are "standardized" to the CME model.
  2. CME model for these examples is Bjerksund and Stensland (1993a) Approximation Model for American-Style Options as referenced in The Complete Guide to Option Pricing Formulas, McGraw-Hill Education; 2 edition (January 8, 2007).

The cost of carry rate will be set to to 0.

Black 76 Model

Black 76 will be the pricing model for European style options.

 Expand for the Complete Formula

Assumptions:

  1. Volatility quotes incoming from Market Maker are "standardized" to CME model.
  2. CME model for these examples is Black Option Pricing Model for European-Style Options as referenced in Natenberg, S. (1994). Option Volatility and Pricing. New York: McGraw-Hill

Equations:

C = (U*e^(-rt)*N(h))-(E*e^(-rt)*N(h-(v*t^0.5)))

U = [C+{E*e^(-rt)*N(h-v*t^0.5)}]/(e^(-rt)N(h))

P = (-U*e^(-rt)*N(-h))+(E*e^(-rt)*N((v*t^0.5)-h))

U = ((E*e^(-rt)*N((v*t^0.5)-h)) - P) / (e^(-rt)* N(-h))

C delta = e^(-rt)*N(h)

P delta = -e^(-rt)*N(-h)

h = (ln(U/E)+(v^2/2)*t)/v*t^0.5

U = [C+{E*e^(-rt)*N(h-v*t^0.5)}]/(e^(-rt)N(h))

where:

C = Call premium

P = Put premium
U = price of underlying contract (Future)
E = expiration (strike) price
t = time to expiration in years (#days/365)
v = annual volatility expressed as a decimal
r = period interest rate assumption expressed in decimal
e = base of the natural logarithm
ln = natural logarithm
N = normal standard distribution

Sample Data Sets

The attached spreadsheet contains sample product listings for American and European volatility-quoted options.

See the Time Decay section.

Volatility-Quoted Options Expiration

The Volatlity-Quoted Options trading schedule will follow the related Premium-Quoted Options trading schedule except for expiration day. Because the volatility model used with Volatlity-Quoted Options does not function on expiration day (i.e., no intra-day decay), the Volatlity-Quoted Options instrument terminates one day prior to the related premium option’s expiration day. On expiration day the option can be only traded in premium until 2:00 p.m. CT. The following table shows the difference between a premium-quoted and volatility-quoted September 2017 Call option.

Example

 

Premium-quoted option

Volatility-quoted option

If traded using instrument code

6A

V6A

Day/Time when volatility-quoted option functionality ends

n/a

07-Sep-2017 at 4:00 p.m. CT

Option expiration day/time

08-Sept-2017 at 2:00 p.m. CT

07-Sept-2017 at 4:00 p.m. CT

Time Decay

 Security Definition( tag 35-MsgType=d) message will indicate day/time when volatility-quoted options functionality ends in tag  864-NoEvents and tag 865-EventType = 7 (i.e. Last eligible trade date).

  • Time decay will be expressed in daily terms or "calendar days to expiration". Calendar days to expiration will be divided by 365 days to equate to a decimal equivalent value.
  • Calendar days to expiration will be defined in CME Globex trade date terms; the CME Globex trade date changes with the 5:00 p.m. CT opening.
  • The calendar days to expiration will be an integer value - there will be no fractional calendar days to expiration (e.g. decay will not be based on hours/minutes/seconds).
  • The VQO's time to expiry will be equated to the PQO expiry date minus one day. For example, if the current date is Wednesday and the PQO expires on the same week and on Friday, then the VQO - during Wednesday's trade date - will have two days to expiry (or three trading days to PQO expiry minus one trading day). This approach will better synchronize the FX VQO expiry approach between CME Globex and the OTC market as the FX OTC expiry occurs early on its last trading day (e.g. 10AM ET).
  • 6A: Premium-Quoted Option expiry = 08-Sept-2017 at 2:00 p.m. CT
  • V6A: Volatility-Quoted Option expiry = 07-Sept-2017 at 4:00 p.m. CT
  • DTE (Days to Expiry) = Remaining expiry days at the beginning of the Trading Session

SEPTEMBER 2017

Sun

Mon

Tue

Wed

Thur

Fri

Sat






1

6A DTE = 8

V6A DTE = 7

2


3

=

4

6A DTE = 5

V6A DTE = 4

5

6A DTE = 4

V6A DTE = 3

6

6A DTE = 3

V6A DTE = 2

7

6A DTE = 2

V6A DTE = 1

8

6A DTE = 1

V6A DTE = 0

9

Volatility-Quoted Options Minimum Order Size

Volatility-quoted option New Orders and Order Modifications will have a 10-lot minimum order size and can be incremented in 1-lot values after the 10-lot minimum order size is met; for example, the client can submit volatility order sizes of 11, 12, 13, etc.

A volatility-quoted option order or order modification submitted with a quantity less than the minimum order size will be rejected with a reason code indicating the required minimum order size was not met, and specifying the minimum order size.

A resting volatility-quoted option order cannot match with a quantity less than the minimum order size.

In the event of a partial fill with remaining quantity less than the required minimum, the following messaging rules apply:

If there are multiple resting quotes for that Instrument Group, the CME Globex platform cancels all resting quotes for all instruments associated with Mass Quote submitter’s Instrument Group.

  • If In-Flight Mitigation (IFM) is used for a volatility-quoted options order modification and the remaining adjusted quantity is less than the 10-lot minimum order size, CME Globex will cancel resting volatility-quoted options order.

Volatility-Quoted Options Match Algorithm

A FIFO algorithm will be applied for matching occurring within volatility-quoted options  order books. There will be no change to the existing match algorithm of the future and premium-quoted books.

Central Limit Order Book (CLOB)

A Volatility-Quoted option CLOB match event creates new futures and options positions exchanged only between the volatility-quoted option CLOB match participants; there is no direct impact on the futures and premium-quoted CLOB's.

Self Match Prevention for Volatility-Quoted Options

Standard CME Globex Self-Match Prevention is available for Volatility-quoted options.

See also the SMP Frequently Asked Questions section 

Mass Quote Protections

Mass Quote Protections currently support a Product Line feature that aggregates Mass Quote Protections for related products within a given asset class. The GCC uses instrument group codes to associate related option products into a given product line. Clients must opt in to use this service.

For Mass Quote Protections, Volatility-quoted options and Premium-quoted options will be configured in same Product Line; a triggered protection will cancel quotes on both Volatility-quoted and Premium-quoted order books.

  • Volatility and Premium quotes must be submitted using a single session. MQP settings are enforced by the SessionID + FirmID sent by the client in tag 49-SenderCompID.
  • The Buy/Sell Mass Quote Protection will only tabulate the Premium-quoted option assignment portion when a Volatility-Quoted option matches; the futures assignment portion will not be counted.
  • The Delta Mass Quote Protection will only tabulate any unhedged delta remaining from the combined futures and Premium-Quoted Option assignments.

Options Pricing Model & Hedge Assignment

VQO CLOB MATCH

Following a volatility-quoted options match, CME Globex performs pricing and hedge quantity assignment as follows:

1. Determine the hedge quantity for the volatility match.

  • The option premium quantity will equate to the volatility match quantity.

2. Determine the option premium price using the following variables applied in the appropriate options pricing model (i.e. the Bjerksund and Stensland (1993a) approximation model for American-style options and the Black 76 model for European-style options):


Volatility

The volatility-quoted options CLOB match percentage value


Underlying Futures Price

The CME Globex option pricing model will use info derived from the underlying futures CLOB. The underlying futures CLOB info will be sampled on an ongoing basis and the data sample can be between 0 to 2 seconds before the volatility-quoted options CLOB match time. Please note that when the Triangulation function is launched then the underlying futures price sample will be calculated concurrent with the volatility-quoted options CLOB match time.

  1. If the volatility-quoted option delivers into the front month quarterly futures:
    1. The assigned futures price will be based on the current bid-ask midpoint of the front month quarterly futures. If the midpoint is not on-tick, then CME Globex will round the futures price tick to the benefit of the short futures position. As such and from the long call and short put perspectives, the selling futures off-tick midpoint price will always be rounded up to the nearest tick. Please note that when the Triangulation function is launched then CME Globex will round an off-tick midpoint futures price to the futures side which has the smaller resting quantity; if the quantity is equal on both sides then it will be rounded to the benefit of the short futures position. 
    2. If the current front month quarterly futures bid-ask tick range is beyond a CME Globex-defined tick range or if there is no bid and/or ask then CME Globex will use its Banding Reference Price as the assigned futures price which - in this scenario - would be the front month quarterly futures most recent C-Last (i.e. most recent of a trade, better bid or ask). Absent a C-Last value, the Banding Reference Price will use the front month quarterly futures previous day settlement price as the assigned futures price.
  2. If the volatility-quoted option delivers into a back month futures:
    1. CME Globex will use the front month quarterly futures calculated price (see above) and will add or subtract the differential between the front month quarterly settlement price and the back month settlement price to produce a synthetic value for the back month underlying futures.

Interest RateThe daily interest rate will be based on the settlement price of the previous day's Eurodollar futures front month quarterly. If the front month Eurodollar futures is the quarterly month then the next quarterly futures settlement price will be used as the interest rate. The Bjerksund and Stensland (1993a) option pricing model will use a 0% cost-of-carry for FX options. Clients will be informed as to the exact interest rate value on www.cmegroup.com/vqo and ftp://ftp.cmegroup.com/VQO/InterestRate.txt.
Time Decay

See the Time Decay section.


OptionStrike Price, C/P, StyleThe volatility-quoted option strike price

The premium-quoted option price resulting from a volatility-quoted trade will have a more granular tick than a premium-quoted trade. When matching occurs directly between volatility-quoted option customer orders, the CME Globex-assigned premium-quoted option price will have a granularity of 1/5th of a tick to provide more precision in the conversion of volatility to premium. The following table shows the standard premium-quoted minimum tick size versus the CME Globex assigned tick size when the premium-quoted option price is assigned as part of the volatility-quoted option match process.

CME Globex U.S. Product Listing

Premium-Quoted Option Minimum Tick Size

Premium-Quoted Option Minimum Tick Size from a Volatility-Quoted Trade

AUD/USD (Australian Dollar)

0.00005 (or $5.00)

0.00001 (or $1.00) 

CAD/USD (Canadian Dollar)

0.00005 (or $5.00)

0.00001 (or $1.00) 

CHF/USD (Swiss Franc)

0.00005 (or $6.25) 

0.00001 (or $1.25)

EUR/USD (Euro FX)

0.00005 (or $6.25) 

0.00001 (or $1.25)

GBP/USD (British Pound)

0.0001 (or $6.25)

0.00002 (or $1.25)

JPY/USD (Japanese Yen)

0.0000005 (or $6.25)

0.0000001 (or $1.25)

3. Determine the futures hedge quantity by multiplying the matched volatility option quantity by the associated delta value for the option.

4. Determine futures price. Price is based on the midpoint of the current Bid and Ask of the front month quarterly futures.

  • If the midpoint is not on-tick, the price will round to the benefit of the short futures position.
  • If no resting Bid and/or Ask is available, the C-Last (most recent trade, better bid, or ask) will be used.
  • If no C-Last is available, the previous day's settle will be used.
It is possible for a volatility match to occur without a futures hedge if the match event's total delta is calculated between > -0.50 and < 0.50. In either instance, the futures hedge rounds to zero. 

Futures Zero Hedge Example

The volatility matched quantity is a 10-lot and its corresponding delta is 0.04. The product of these two multiplied factors equates to a match event's total delta of 0.40 (10-lot * 0.04 delta). A volatility match occurs without a futures hedge since the match event's total delta is rounded to zero.

The delta for the futures hedge is sent in the Execution Report (tag 35-MsgType=8) Fill message for the option premium outright instrument(s) in tag 811-OptionDelta.

CME Globex does not send an Execution Report for a futures hedge when the futures hedge quantity rounds to zero.

Hedge Assignment with Multiple Counterparties Example

If a single volatility match has multiple counterparties, then the incoming delta is determined for the entire incoming order. The match event's' total delta for each counterparty is determined individually for each resting order.

Step 1: CME Globex determines the incoming volatility-quoted option's total hedged futures.

1. The incoming (aggressing) Volatility-Quoted Option order's delta is rounded up to the next 100 delta value when its unhedged delta value is from 50 thru 99.

2. The incoming (aggressing) volatility-quoted option order's delta is rounded down to the next 100 delta value when its unhedged delta portion is from 01 thru 49.

    • A total delta value calculated between 01 thru 49 will be rounded to a zero delta value.

3. The number of futures assigned to the incoming (aggressing) volatility-quoted option order equates to the rounded delta value.

    • Long calls + short puts are assigned short futures.
    • Short calls + long puts are assigned long futures.

Example A: If an incoming (aggressing) volatility-quoted option order is calculated to have +1150 total deltas then 12 short hedged futures would be assigned. The volatility-quoted option would be unhedged -50 deltas (or -50 deltas = +1150 total deltas - 1200 short hedged futures deltas).

Example B: If an incoming (aggressing) volatility-quoted option order is calculated to have +349 total deltas then 3 short hedged futures would be assigned. The volatility-quoted option would be unhedged +49 deltas (or +49 deltas = +349 total deltas - 300 short hedged futures deltas).

Step 2: CME Globex determines the total deltas for each resting order which matched.

Step 3: CME Globex rounds each resting order's delta down to its nearest 100 delta value and allocates the related number of futures.

Step 4: If remaining futures need to be allocated to make the incoming volatility-quoted option order whole then the futures are distributed in a 1-lot increment sequence to the resting volatility-quoted option order(s) which have the most unhedged delta from the match event. If multiple, resting volatility-quoted option orders have the same unhedged delta value then earliest timestamp serves as the tiebreaker.  

Example C: The below volatility-quoted option resting Ask orders are matched by an incoming volatility-quoted option Bid order; the CME Globex calculated delta is 53.

Step 1: CME Globex determines the incoming volatility-quoted option's total hedged futures.

74 futures are assigned to the incoming volatility-quoted option order. (7400 deltas = volatility-quoted option 140-lot * 53 delta).

Step 1

Determine Incoming volatility-quoted option's allocated futures

QtyVol Bid %Vol Ask %Qty

74 futures assigned (or 53 delta * 140 = 7420 rounded down to 7400)

14015.2215.2250




40




30




20

Step 2: CME Globex determines the total deltas for each resting order which matched.

Step 1

Determine incoming volatility-quoted option's allocated futures

QtyVol Bid %Vol Ask %Qty

Step 2

Resting Orders Total Delta

74 futures assigned (or 53 delta * 140 = 7420 rounded down to 7400)

14015.2215.22502650




402120




301590




201060

Step 3: CME Globex rounds each resting order's delta down to its nearest 100 delta value and allocates the related number of futures.

Step 1

Determine incoming volatility-quoted option's allocated futures

QtyVol Bid %Vol Ask %Qty

Step 2

Resting Orders Total Delta

Step 3

Resting Order Deltas Rounded Down & Futures Allocated

74 futures assigned (or 53 delta * 140 = 7420 rounded down to 7400)

14015.2215.22502650

2650 deltas; 26 futures allocated

50 remaining deltas





402120

2120 deltas; 21 futures allocated

20 remaining deltas





301590

1590 deltas: 15 futures allocated

90 remaining deltas 





201060

1060 deltas; 10 futures allocated

60 remaining deltas

Step 4: If remaining futures need to be allocated to make the incoming (aggressing) volatility-quoted option order whole then the futures are distributed in a 1-lot increment sequence to the resting volatility-quoted option order(s) which have the most unhedged delta from the match event. If multiple volatility-quoted option orders have the same unhedged delta value then earliest timestamp serves as the tiebreaker.  

There were 72 futures allocated after Step 3 and an additional 2 futures need to be allocated to make the inbound Bid order's hedge quantity whole for a total of 74 futures. The remaining two futures are allocated in 1-lot increments to the orders which have the most unhedged delta from the match event.

Step 1

Determine Incoming volatility-quoted option's Allocated Futures

QtyVol Bid %Vol Ask %Qty

Step 2

Resting Orders Total Deltas

Step 3

Resting Order Deltas Rounded Down & Futures Allocated

Step 4

Remaining Futures Allocated to Resting Orders

74 futures assigned (or 53 delta * 140 = 7420 rounded down to 7400)14015.2215.22502650

2650 deltas; 26 futures allocated

50 remaining deltas






402120

2120 deltas; 21 futures allocated

20 remaining deltas






301590

1590 deltas: 15 futures allocated

90 remaining deltas 

1 additional futures allocated for 16 total futures




201060

1060 deltas; 10 futures allocated

60 remaining deltas

1 additional futures allocated for 11 total futures

On a per volatility match level, the incoming (aggressing) volatility-quoted option order will never be out more than 50 deltas. A resting volatility-quoted option order can be out between 1-99 deltas. However, if the resting volatility-quoted option order is the only order that matches, then it will never be out more than 50 deltas. 

Additional Considerations

  • CME Direct supports volatility-quoted options.

  • CME Globex Credit Controls apply to volatility-quoted option orders:

    • Each volatility-quoted option instrument is assigned a margin value that is equal to the related premium-quoted option instrument.

  • Price banding applies for volatility-quoted options, but no daily limits:

    • If the underlying future is halted, then both the premium-quoted options and the volatility-quoted options will be automatically halted.

  • Volatility-quoted options trade volume is not reported on Volume and Open Interest (VOI), but the assigned option and hedged future will be reported as part of VOI.

  • Settlement price is not published for volatility-quoted options on a daily basis.

  • Volatility-quoted options are not eligible for block trades and/or Ex-Pit transactions.
  • Volatility-quoted options spreads are not supported.
  • User-Defined Spread (UDS) functionality is not available for volatility-quoted options.
  • Volatility-quoted options does not support Request-for-Cross functionality.
  • Volatility-quoted options does not support Display Quantity Order functionality (aka "max show")