TABB Says Trading of VIX Products Has Grown at a 5-Year CAGR of 130%, Introducing Lucrative Arbitrage Opportunities

New Research Says that VIX ETPs May Be Influencing the Price of the Index Products They are Designed to Track

NEW YORK & LONDON--(EON: Enhanced Online News)--Traders tell TABB Group that VIX exchange-traded products (ETPs) have been a key driver behind the trading of VIX futures and options, expanding at a five-year compound annual growth rate (CAGR) of 130%, quite possibly influencing the price of the index the products they have been designed to track. “Although this may be a ‘tail wagging the dog’ situation,” says Henry Chien, author of new research published today, “VIX Trading: The Structure of Uncertainty,” “this opens the door to a number of lucrative arbitrage opportunities.”

“this opens the door to a number of lucrative arbitrage opportunities.”

Based on the VIX ETP market’s year-end assets, says Chien, a New York-based TABB research analyst, levered and inverse ETPs accounted for 13% of all VIX ETP notional value traded in 2011, with the VIX product set of futures, options and ETPs trading $3.4 billion average in daily notional value. During this period, the S&P 500 volatility market reached an estimated 202 million average daily notional Vega (gross): SPX Options (75 million); VIX futures (48 million); VIX Options (39 million); VIX ETPs (30 million); and SPX Variance Swaps (10 million).

TABB’s “VIX Trading” research explores the growth of VIX products designed to meet institutional and retail investors’ demands for risk-management products incorporating hedging, diversification and tail risk, and the evolution of the S&P 500 implied volatility market. Based on interviews with sell-side brokers, market makers, hedge funds, proprietary trading groups, exchange-traded product issuers and exchanges, the 21-page report with 8 exhibits examines the drivers behind the eco-system of VIX products – from VIX ETPs, VIX futures and options and OTC variance swaps, to delta-hedged SPX options – and their potential impact on the overall US options market structure.

According to TABB, liquidity in the volatility market has shifted to products that give exposure to implied volatility, resulting in a combination of VIX product growth and an investor trend towards product simplicity. By attracting traditional asset managers and retail investors into the volatility market, ETPs are creating trading opportunities for market makers, dealers and prop traders, with VIX ETP growth likely to influence the underlying VIX futures term structure.

In today’s highly correlated, highly volatile environment, Chien suggests that issuers, index companies and banks should continue to develop VIX products that facilitate sophisticated strategies and allow investors to make increasingly complex market bets using simplified mechanisms. “With the cost of hedging skyrocketing,” he says, “traders who know how to price and arbitrage volatility should thrive because fund managers can no longer ignore the impact of volatility on their portfolio returns.”

The report is available for download by TABB Group Research Alliance Derivatives clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. For an executive summary or to purchase the report, visit http://www.tabbgroup.com or write to [e-mail].

About TABB Group

TABB Group is the financial industry’s only strategic advisory and research firm focused solely on capital markets, based on the proven interview-based research methodology of “first-person knowledge” developed by founder Larry Tabb. For more information, visit www.tabbgroup.com. In January 2010, TABB launched TabbFORUM, the online capital markets community covering opinions and analyses on current industry issues.