Euro fixed income options at Eurex Exchange. May 2017

Euro fixed income options at Eurex Exchange May 2017

Agenda Options on Euro fixed income futures Product outline Contract specifications Volume and liquidity development Volume and open interest Screen liquidity for calls and puts Finessed options trading with tailored strategies Product nuances and applications Risk mitigation in fixed income options Hedge government bonds exposure Enhance returns with options Utilize implied volatility Where Euro-Bund options differ from Treasuries 2

Product outline Bond trading is complemented by fixed income futures that are physically deliverable with government bonds of different maturity ranges. Fixed income options on futures let investors finesse their bond portfolios with calls and puts for a range of tenors and exercise prices. The long history of floor-based options trading by institutional and local players favored the evolution of a professionals market in Eurex fixed income options. Eurex established electronic quotation in fixed income options and offers permanent and advanced Market Making programs, complemented by quotation programs for option strategies. Besides matching in liquid order books, trades are also negotiated by bank dealing desks, inter-dealer brokers and professional market makers in a competitive price finding process over the phone. 3

Contract specifications Options on Euro-Bund Futures Euro-Bobl Futures Euro-Schatz Futures Underlying Futures on notional short-, medium- or long-term debt instruments issued by the Federal Republic of Germany Contract size Price quotation One fixed income futures contract In points with two or three decimal places Minimum price change 0.01 points (tick value: 10 EUR). 0.005 points (tick value: 5 EUR). 0.005 points (tick value: 5 EUR). Contract months Settlement Up to 6 months: The three nearest successive calendar months, as well as the following quarterly month of the March, June, September and December cycle thereafter The exercise of an option on fixed income futures results in the creation of a corresponding position in the fixed income futures for the option buyer as well as the seller to whom the exercise is assigned. The position is established after the Post-Trading Full Period of the exercise day, at the agreed exercise price Daily settlement price Last trading day The daily settlement price is established by Eurex. The daily settlement prices for options on fixed income futures are determined trough the binomial model according to Cox/Ross/Rubinstein Last trading day is the last Friday prior to the first calendar day of the option expiration month, followed by at least two exchange days prior to the first calendar day of the option expiration month Block trade size 100 contracts 200 contracts 300 contracts Fixed income options give investors the right or obligation to buy or sell the underlying at the strike price. Expiries up to six months are available. They are listed as American style options and settle into a long or short position in the underlying fixed income futures. 4

Agenda Options on euro fixed income futures Product outline Contract specifications Volume and liquidity development Volume and open interest Screen liquidity for calls and puts Finessed options trading with tailored strategies Product nuances and applications Risk mitigation in fixed income options Hedge government bonds exposure Enhance returns with options Utilize implied volatility Where Euro-Bund options differ from Treasuries 5

Traded Volume Open Interest Fixed income options at Eurex Exchange May 2017 Volume development 12,000,000 6,000,000 10,000,000 5,000,000 8,000,000 4,000,000 6,000,000 3,000,000 4,000,000 2,000,000 2,000,000 1,000,000-1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 2013 2014 2015 2016 2017 - OGBL - Options on Euro-Bund Futures OGBS - Options on Euro-Schatz Futures OGBM - Options on Euro-Bobl Futures Fixed Income Options Open Interest 2016 daily average volume in Euro-Bund options lies at 147,000 contracts. Euro-Bobl and Euro-Schatz options showed daily average volumes of 37,000 and 47,000 contracts respectively. Open interest typically builds up to 2.0 million contracts going towards the quarterly futures maturity month, and then drops off by circa one million contracts. 6

Liquidity overview Liquidity is deepest for the options expiries based on the liquid front month futures. Euro-Bund options are quoted between 1 and 3 ticks wide for out of the money and at the money strikes. Typical sizes of quotes on the inside market varies from 250 to 1,500 contracts. Euro-Bobl options are quoted in sizes between 50 and 500 contracts.. A tighter range of strikes are in investor focus for Euro-Bobl and Euro-Schatz options alike due to lower price volatility and persisting negative yields. Euro-Bobl and Euro-Schatz options are bound by the expansionary monetary policy from the ECB, as the futures trade in a very tight price range and feature very low price volatility. 7

Liquidity overview back months Back month fixed income futures are quoted for 2 ticks, but do not match the market depth of front month futures. Advanced Market Makers provide quotes in Euro- Bund, Euro-Bobl and Euro-Schatz options based on the respective back month futures contract. This provides price guidance for investors, and has further improved the quality of daily settlement prices. However, futures rolls are quoted and become liquid later in time as the quarterly expiry approaches, and volume potential is not fully tapped in deferred expiries. 8

Average order book metrics for front month Euro-Bund options Avg B O Spread Call Avg Bid Volume Avg Ask Volume Dec 2016 Mar 2017 Strike Price Avg Bid Volume Avg Ask Volume Avg B O Spread Put Avg B O Spread Call Avg Bid Volume Avg Ask Volume Strike Price Avg Bid Volume Avg Ask Volume Avg B O Spread Put 156.5 198 830 0.01 155.5 330 1204 0.01 157 287 980 0.02 156 579 867 0.01 157.5 325 720 0.02 156.5 585 778 0.02 158 385 697 0.03 157 596 826 0.02 158.5 351 573 0.02 157.5 520 632 0.05 159 362 584 0.05 158 509 486 0.02 159.5 271 498 0.04 158.5 375 354 0.03 160 272 343 0.07 159 275 307 0.07 160.5 268 357 0.03 159.5 252 221 0.08 161 196 270 2.67 160 213 162 0.11 161.5 142 227 0.04 160.5 173 171 0.11 0.15 76 138 162 167 162 0.06 0.05 210 258 161.0 101 102 0.22 0.15 116 118 162.5 0.03 297 365 161.5 0.14 185 159 163 0.04 259 417 162 0.05 264 255 163.5 0.03 243 400 162.5 0.04 361 308 164 0.03 302 602 163 0.03 390 395 164.5 0.02 334 783 163.5 0.03 348 493 165 0.02 250 838 164 0.04 319 524 165.5 0.04 342 955 164.5 0.04 202 580 166 0.01 298 845 165 0.02 186 538 166.5 0.01 447 679 165.5 0.02 182 639 167 0.01 370 731 166 Volatility levels were in excess of 6 % in December 2016. Euro-Bund options showed widened bid offer spreads at higher average executable sizes for out of the money options. Volatility levels were lower in March 2017 at ca. 4.5 %. Bid offer spreads were tighter executable sizes were higher for out of the money options. 9

Strategy Wizard - volume in fixed income options Contract OGBL PBUT Jul17 159 159.50-160 Last Price CBQty CBid CAsk CAQty 0.02 Traded Volume 2.234 0.01 0.02 1.100 6.500 OGBL BER Jun17 160-159 0.2 1.176 0.16 0.18 88 1.775 OGBL BER Jun17 161-160 0.52 162 0.49 0.51 241 1.616 OGBL BER Jun17 160-158 0.27 429 0.2 0.22 52 1.500 OGBL CDIA Jun17 163 Jul17 164 0.3 241 0.31 0.34 116 1.000 OGBL PDIA Jun17 160 Jul17 162 0.71 54 0.68 0.71 50 1.000 OGBL RBER Jun17 159.50 158.50-0.1 118-0.07-0.05 48 1.000 OGBL STD Jun17 160.50 0.84 30 0.83 0.87 96 962 OGBL BLT Jul17 Aug17 161 0.33 329 0.32 0.33 50 951 3,000,000 2,500,000 2,000,000 1,500,000 1,000,000 500,000 - Volume OGBL (Strategy Wizard) 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 2013 2014 2015 2016 2017 Orderbook Volume OGBL Block Trade Volume OGBL Clients can request option strategies via the Eurex GUI and trading front-ends. 20,000 fixed income options contracts traded in the option strategy order books per day in 2016. Overall, strategy trading comprises about 30 percent of volume both in order book and off-book trading. Over 7,000 contracts trade every day directly against Market Maker quotes in option strategies. As in trading outright calls and puts, mid-market trading with limit orders is also prevalent in option strategies. 10

Agenda Options on euro fixed income futures Product outline Contract specifications Volume and liquidity development Volume and open interest Screen liquidity for calls and puts Finessed options trading with tailored strategies Product nuances and applications Risk mitigation in fixed income options Hedge government bonds exposure Enhance returns with options Utilize implied volatility Where Euro-Bund options differ from Treasuries 11

Risk mitigation in fixed income options Liquidity providers Specialized options Market Makers Swaptions/options dealing desks of banks Liquidity providers Sell side Sell side Derivatives bank dealing desks Execution brokers Inter-dealer brokers Liquidity providers Specialized options Market Makers swaptions/options dealing desks of banks Buy side Buy side Portfolio managers from insurers and traditional asset managers Hedge funds CTAs 12

Hedge exposure to European government bonds markets Tender date Issuance Volume Coupon Maturity date 07.06.2017 Bobl DE0001141752 14.06.2017 Bund DE0001102416 21.06.2017 Bund DE0001135481 27.06.2017 Schatz DE0001104685 05.07.2017 Bobl DE0001141760 3.0 bn (R) 0.00 % 08.04.2022 3.0 bn (R) 0.25 % 15.02.2027 1.0 bn (R) 2.50 % 04.07.2044 4.0 bn (R) - 14.06.2019 4.0 bn (N) - 07.10.2022 Protect bond portfolios against price risks Outright options and directional trading strategies with call and put spreads can mitigate the negative impact of unfavorable price developments in the underlying fixed income futures and cash bond markets. Hedge risks from government bond issuances The German Finance Agency auctions off German government debt, but the members of the bidding group may not want to buy every bond they would need to fulfil their bidding quotas. Options can mitigate the price risks when bonds are auctioned, or can be used to lay off bond positions in the secondary markers. 13

Enhance returns with option based strategies Call spread Euro-Bund options Euro-Bund versus 10 y Treasury futures volatility spread 12 Implied volatility of at-the-money Bund and Treasury options 10 8 6 4 2 0-2 -4 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Dec-15 Feb-16 Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 Bund Treasury Treasury-Bund Vol Spread Covered call writing on bond and futures portfolios is commonly pursued for yield enhancement. Investors express market views on fixed income futures and cash bond markets with calls, puts and directional spreads. Explore spreads between Euro and Dollar government bond yield curves. Use inter-product spread trading in price and in volatility terms. 14

Utilize implied volatility Skew of 1M Euro-Bund options: March to May 17 Volatility surface for Euro-Bund options Systematic short volatility These trading strategies can improve returns in times of range bound underlying prices, for example around a core portfolio of bonds and futures. Volatility sensitive strategies Strategies such as butterflies and condors are well suited to pinpoint price developments in government bond markets. Volatility arbitrage between listed fixed income options and OTC swaptions Institutional investors active in swaptions and swaptions dealers mostly look at term structure and skew to Euro-Bund options volatility to test sensitivities and potentially exploit misbalances. 15

Where Euro-Bund options differ from Treasuries The major peer and competitor for trading in options on fixed income futures is by far the CME with its Treasury options complex that trades over half a million contracts per day. Historically, the U.S. cash and derivatives markets have benefited from a larger, homogeneous government bond market with only one sovereign issuer, the Treasury. U.S. markets for cash bonds have evolved to electronic trading whereas most secondary markets for government bonds still trade OTC in Europe. And then there are screens, pits and phone markets: The CME has brought Treasury options from the pit to electronic trading that now sees ca. 70 percent of this volume. Market Makers at CME participate in up to 40 percent of an incoming client order's size by virtue of their screen quotation performance score, raising the bar for new market (making) entrants. Quotes given by Market Makers in phone markets are independent from one another, alone by merit of separate physical trading locations. 16

Further information / Contact us Sales Continental Europe Sales Zurich Paul Beck Eurex Frankfurt AG Neue Börsenstraße 1 60487 Frankfurt / Main Germany P: +49 (0)69 2 11-1 20 42 F: +49 (0)69 2 11-61 44 77 paul.beck@eurexchange.com Markus-Alexander Flesch Eurex Zürich AG Selnaustrasse 30 8021 Zürich Switzerland P:+41 (0)58 3 99-29 48 F:+41 (0)58 4 99-24 66 markus-alexander.flesch@eurexchange.com Sales UK Sales Americas Sales Asia & Middle East Stuart Heath Deutsche Börse AG UK Representative Office One Canada Square, Canary Wharf London, E14 5DR United Kingdom P: +44 (0)207 8 62-72 53 F: +44 (0)207 8 62-92 53 stuart.heath@eurexchange.com Vassilis Vergotis Eurex 233 South Wacker Drive - Suite 2450 Chicago, IL 60606 USA P: +1 312 5 44-10 58 F: +1 312 5 44-15 58 vassilis.vergotis@eurexchange.com Roland Schwinn Eurex Frankfurt AG 50 Raffles Place No. 21-05 Singapore Land Tower Singapore 048623 P: +65 6304-52 52 F: +65 6304-52 80 roland.schwinn@eurexchange.com 17

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