HSI Volatility Index ( VHSI ) Daniel Wong Senior Vice President, Research & Development 24 March 2011
Contents Background of VHSI What is VHSI Measuring? Index Methodology Back History of VHSI Background of the VHSI
Background of the VHSI
Why HK Needs a Volatility Index? Market demand Hong Kong has an active derivative market and derivative pricing depends on volatility Volatility index can help hedge fluctuating volatility CBOE VIX on S&P500 gained a lot of attention during the financial turmoil
How to Construct a Volatility Index for HSI (VHSI)? Different people may have different ways to measure volatility Historical volatility from HSI movements Implied volatility from individual options or warrants Volatility Index is based on a whole spectrum of options
About the VHSI Launched on 21 February 2011 Measures 30-day Expected Volatility of HSI Adopt CBOE VIX Methodology With Local Modifications for Hong Kong markets with HKEx and market input HSIL and HKEx jointly conducted market consultation with derivatives traders in Nov-Dec 2009 and obtained general acceptance on the VHSI methodology and modifications proposed
What is VHSI measuring?
What Does VHSI = 25 Mean? Statistically: VHSI is measuring a 30-day Expected Annualized Volatility of HSI (in terms of Std. Dev.) If VHSI=25 the Expected Volatility in the coming 30 days is 25% / 12 = 7.2% 95.4% chance 14.4% (within 2 s.d.) VHSI = 25 68.2% chance 7.2% (within 1 s.d.) Expected return <> 0 Low VHSI High VHSI assume 30-day expected return = 0
Index Methodology
Index Calculation Mechanism Near-term Determine At-the-money Strike Price Next-term Determine At-the-money Strike Price Select Relevant Options for Inclusion in the Calculation Calculate Time to Expiration Select Relevant Options for Inclusion in the Calculation Calculate the Near-term Implied Volatility Interpolate Riskfree Rate Calculate the Next-term Implied Volatility Interpolate 30-day Expected Volatility VHSI
Index Formula Apply the CBOE VIX formula to calculate the near-term volatility ( 1 )and the next-term volatility ( 2 ): σ = Implied volatility T = Time to expiration in years F = Forward index level Ki = Strike price of the i th out-of-the-money option; a call if Ki > K0 and a put if Ki < K0; both put and call if Ki = K0. ΔKi = Interval between strike prices K0 = First strike below the forward index level (F) R = Risk-free interest rate to expiration Q(Ki) = Mid-price of each option with strike Ki Note: Please refer to the methodology book for detail information.
Index Formula (Cont d) Interpolate, i.e. 30-day Expected Volatility, by 1 and 2 σ = 30-day Implied volatility σ1 = Near-term volatility derived from the near term options σ2 = Next-term volatility derived from the next term options N30 = 30 days N365 = 365 days T1 = Time to expiration (in years) of the near term options T2 = Time to expiration (in years) of the next term options NT1 = # of days to expiration of the near term options NT2 = # of days to expiration of the next term options Near-term vol. 1 2 30-day vol. 2 Near-term vol. 2 2 VHSI = 8 30 38 (Days) Note: Please refer to the methodology book for detail information.
Modification on Options Selection CBOE VIX: No selection range for CBOE VIX; Once two consecutive call / put options with no midprice, calls with higher strikes / puts with lower strikes are excluded VHSI : Select options with strike prices within 80% ~ 120% range around the at-the-money Strike
Modification on Options Selection...Cont d Strike Option Type Bid-ask average 18800 Put 41 19000 Put 47.5 19200 Put 52.5 19400 Put 59.5 21400 Put 203.5 23400 Put 704.5 23600 Put / Call Average 829 23800 Call 761 26400 Call 92.5 28000 Call 22.5 28200 Call 6 28400 Call 5 Out-of-Money Put Options within 80% of the ATM Strikes At-the-Money Strikes Out-of-Money Call Options within 120% of the ATM Strikes
Modification on Options Selection...Cont d Illustration: As at market close of 25 Oct 2010 Next-term Strike Option Type Mid-price 18800 Put 41 19000 Put 47.5 19200 Put 52.5 19400 Put 59.5 20600 Put 125.5 20800 Put - 21000 Put - 21200 Put - 21400 Put 203.5 23400 Put 704.5 23600 Put / Call Average 829 23800 Call 761 26400 Call 92.5 26600 Call - 26800 Call - 27000 Call 55.5 28000 Call 22.5 29000 Call 6 30000 Call 5 Screening by a 80%-120% range, strikes from 19000 to 28000 with mid-prices will be selected for VHSI calculation. No mid-price for three consecutive strikes Screening by the Two Consecutive Rule, only strikes from 21400 to 26400 will be selected for VHSI calculation. No mid-price for two consecutive strikes
Modification on Options Selection...Cont d Justification: The 80% - 12% Range: Can Avoid Price Anomalies: Avoid including illiquid far out of money options with abnormal bid / ask prices. Has Extensive Coverage: Already cover about 80% of the options trading in different market situation. In HK Market, Removing the Two Consecutive Rule Could: Enhance Representativeness: The Two Consecutive Rule may lead to exclusion of options with high liquidity in HK market, which will lower the representativeness of the VHSI being calculated. Avoid Unnecessary Shocks: The Two Consecutive Rule may lead to shocks in the VHSI value due to sudden change in the set of options selected for calculation.
Modification on Index Open Time CBOE VIX: Opens when option market opens VHSI: Opens at 9:30 am, i.e. same as Cash Market opening time 20 9:30 am when the VHSI opens VHSI in the morning of 16 Sep 2010 19.5 19 18.5 18 1. Index shocks were observed during the initial 15 minutes after the market opens. 2. After the cash market open, the options trading becomes more liquid. 17.5 9:45:00 9:15 am AM 10:10:00 9:45 am AM10:15 10:35:00 am AM 10:45 11:00:00 am 11:15 AM 11:25:00 am 11:45 AMam 11:50:00 12:15 AM pm 12:15:00... PM
Other Modifications CBOE VIX Methodology Modification of VHSI Rolling (to avoid price anomalies of expiring options) 8 calendar days prior to expiration of the near-term option 5 trading days prior to expiration (to avoid long holiday, such as CNY, Christmas, etc...) Holiday Last trading day Roll to use Jan & Feb options 21-day HIBOR 1-month Risk Free Rate The bondequivalent yield of the U.S. T-bill Latest HIBOR Fixing provided by HKAB HIBOR 1-week Time to expiration of the near-term option
Characteristics Selection of Constituents for Index Calculation Not using a fixed set of options; Select available option quotes in the Market, according to the selection rules, i.e. include ATM options and out-of-money call / put options within 80% -120% of the ATM strike Cannot Always Be Calculated At some specific time points, market might not have sufficient quotes for index calculation HSIL s Solution VHSI will carry the previous index value when calculation of VHSI is not rendered possible for any particular time point.
Smoothing the Abnormal Index Value Index Could Jump Occasionally, the VHSI could jump up and down in subsequent index ticks, or vice versa, suddenly due to sudden changes in collection of option price data. Smoothing Mechanism In case the calculated VHSI shows a tick-by-tick movement (either up or down) > 5% from the last disseminated index value, such a calculated index would be regarded as an abnormal index and will not be disseminated and will carry the last disseminated index value. If such an abnormal index persists for 4 consecutive ticks, it will be regarded as normal and will be disseminated. This treatment for abnormal index will not be applied for the first and last index ticks in each trading session.
Smoothing the Abnormal Index Value 25 24 VHSI 23 22 21 11/9/2010 Tue 10:00:00 11/9/2010 Tue 14:30:00 25 24 Smoothed VHSI (4 tick) After smoothing 23 22 21 11/9/2010 Tue 10:00:00 11/9/2010 Tue 14:30:00
Back History of VHSI
Performance Comparison VHSI vs HSI VHSI VHSI Vs HSI (2 Jan 2001-18 Feb 2011) HSI 120 100 80 VHSI HSI Ann. Vol. VHSI = 71.3% HSI = 25.6% Lehman Brothers Bankruptcy 35,000 30,000 25,000 20,000 60 40 911 Attack Subprime Aggravation 15,000 10,000 20 5,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 - VHSI 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 10-year High 43.77 36.37 28.92 28.69 20.67 23.73 48.30 104.29 60.51 39.29 Low 20.99 16.38 16.52 13.69 10.86 13.64 16.73 25.32 22.64 16.89 Close 26.54 19.14 22.15 16.18 15.54 19.74 35.53 53.88 22.68 18.09 Average 27.22 23.25 21.25 19.95 14.44 17.10 26.92 45.50 37.47 22.26 25.52
101-102 Distribution of VHSI Over the Past 10 Years 16% 14% 12% 10% 17 25 accounted for ~ 50% 8% 6% 4% 2% 0% 91-92 0-2 11-12 21-22 31-32 41-42 51-52 61-62 71-72 81-82
Performance Comparison VHSI vs HSI 30.0% 40% 14.4% 30% VHSI Daily Return 20% 10% 0% -15% -10% -5% 0% 5% 10% 15% 20% -10% 18.3% Period: 2001-2010 -20% HSI Daily Return 37.3%
Changing Correlation between VHSI and HSI 0.00 Rolling 1-year Correlation Between HSI & VHSI -0.10-0.20-0.30-0.40-0.50 Correlation (2 Jan 2008 11 Mar 2011): -0.60 21 Apr 2010 (-0.39) -0.60-0.70 29 Oct 2008 (-0.71) -0.80 2008 2009 2010 2011
When The Market Was Stable (2005 06) VHSI 25 VHSI VHSI Vs HSI (3 Jan 2005-29 Dec 2006) HSI 25,000 20 HSI 20,000 15 15,000 10 5 0 01/05 02/05 03/05 04/05 05/05 06/05 07/05 VHSI ranged from 10 ~ 25 08/05 09/05 10/05 11/05 12/05 01/06 02/06 03/06 04/06 05/06 06/06 07/06 08/06 09/06 10/06 11/06 12/06 10,000 5,000 Max. Min. Avg. Ann. Vol. Correl. VHSI 23.73 10.86 15.77 59.9% HSI 20,002 13,355 15,616 12.9% - -0.54
When The Market Was Volatile (Sep Nov 2008) VHSI 120 21,042 100 80 60 VHSI Vs HSI (Sep - Nov 2008) VHSI 104.29 HSI VHSI ranged from 60 ~ 80 Dropped by 48% in 2 months HSI 25,000 20,000 15,000 40 31.41 11,016 on 27 Oct 10,000 20 VHSI ranged from 30 ~ >100 5,000 0 01/09 08/09 16/09 23/09 30/09 09/10 16/10 23/10 30/10 06/11 13/11 20/11 27/11 - Max. Min. Avg. Ann. Vol. Correl. VHSI 104.29 31.41 61.29 131.0% HSI 21,042 11,016 15,994 76.7% -0.70
-End - More Information at www.hsi.com.hk/volatilityindex
Disclaimer HSI Volatility Index (the Index ) is published by Hang Seng Indexes Company Limited ( HSIL ), which has contracted with Standard & Poor s Financial Services LLC ( S&P ) to maintain and calculate the Index. Standard & Poor's" and "S&P" are trademarks of S&P and have been licensed for use by HSIL. VIX is a trademark of Chicago Board Options Exchange, Incorporated ( CBOE ) and S&P has granted a license to HSIL, with permission from CBOE, to use such mark for purposes relating to the Index. The Index is not owned, sponsored, endorsed or promoted by S&P or CBOE and neither S&P nor CBOE makes any representation regarding the advisability of investing in products that are based on such Index or otherwise relying on such Index for any purpose and neither S&P, CBOE nor HSIL shall have any liability for any errors or omissions in the Index or any values thereof. All information contained herein is provided for reference only. Hang Seng Indexes Company Limited ( HSIL ) ensures the accuracy and reliability of the above information to the best of its endeavours. However, HSIL makes no warranty or representation as to the accuracy, completeness or reliability of any of the information contained herein and accepts no liability (whether in tort or contract or otherwise) whatsoever to any person for any damage or loss of any nature arising from or as a result of reliance on any of the contents of this document, or any errors or omissions in its contents and such contents may change from time to time without notice The information contained in this document is not intended to provide professional advice and should not be relied upon in that regard. Persons intending to use any information obtained from this document are advised to obtain appropriate professional advice. Hang Seng Indexes Company Limited 2011. All rights reserved.
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