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Buxl option as a tool for dealers
The euro vol market has endured some big moves over the past year, ranging from a sharp spike in March 2020 (as long-end yields collapsed) to heavy selling through Q4 2020 (amid huge investor appetite for callable structures).
Therefore it comes as no surprise that several OTC option desks have said they welcome the launch of options on Buxl futures (OGBX) by Eurex. “It’s always useful to have a new instrument,” said the head of one London-based OTC option desk. Another senior trader at a different bank agreed, “It should become more popular and more useful.”
Speaking to Total Derivatives, a majority of OTC traders report they are most likely to use the OGBX contract as a hedging tool.
Specifically, one dealer suggested that given the current ratio of 30y vs 10y OTC vol relative to OGBX vs OGBL, the Buxl option is best suited to hedging short 30y gamma positions that a desk might be running. “It is looking a bit on the low side in terms of ratios, so if it were to be used I would imagine that OTC dealers would look to buy it versus any short gamma positions they are holding in 30y,” he explained.
Meanwhile, other desks highlight the potential of OGBX for spread trading, particularly given vol dealers increasingly look to enter spread trades when hedging positions.
For example, a trader might find 30y vol to be rich and therefore look to sell, but typically will look for another area of the surface to buy against, e.g. selling 30y vs buying 10y vol. “You already see that type of interest in the US listed options market and it’s something we need even more so in euros,” felt one dealer.
Grappling with liquidity
While OTC desks have broadly welcomed the arrival of options on Buxl futures, some dealers remain cautious - given its status as a relatively new contract.
As one explained, “I don’t think liquidity is fantastic at the moment, so it’s not something you would want to dive into. Most likely it will be used as a hedging tool when there isn’t much else to hedge with.” Another trader tended to agree, “It’s a tricky thing to quote in an option market because the underlying future is illiquid.”
At the crux of the issue for OTC desks is the Buxl asset swap and the wild moves that can occur, such as March last year when the spread shot up to 45bps only to sink back down to 20bps in a matter of days amid a funding squeeze as coronavirus rattled markets.
“During the big moves in the market the Buxl asset swap can move a lot, both for and against you if you are long gamma, so that will make dealers hesitant to build up too much of a large position versus OTC,” reckoned one dealer.
Meanwhile, some traders see similarities between the Schatz option and Buxl option, “The Schatz asset swap can become quite dislocated and trade as its own product. In that respect, the Buxl option is sort of similar to the Schatz in that it can behave by itself and is less regulated by what the swap market is doing, meaning it is riskier running a position than in OTC.”
Still, it should be noted that Eurex has been quick to address some of the challenges since launching the option, such as bringing on board a wide range of market-makers. For more on such measures, see the article Eurex on Buxl options, market makers and advantages for end-users.
Client execution - OTC desks or ETD brokers?
Another opportunity for banks is to position themselves directly as market-makers to clients. Typically, banks do not make prices on listed products because, unlike OTC markets, they do not face an obligation to quote on the exchange.
However, one dealer agreed that from a client relationship perspective, it can make sense for a bank to step-up and make a price in listed derivatives. “There are some banks that can provide block prices for exchange products and it tends to depend on liquidity, the instrument and whether it suits a bank or not. Also, some clients do prefer to use OTC desks because it’s easier to ask for a price in size, have it done and then move on.”
Another source agreed, “There isn’t always an incentive for OTC desks to make prices in listed products, but obviously if more and more clients start asking then things can change.”
Indeed, speaking in a previous article, the asset manager Aegon has stated that it executes Buxl options directly with a bank, see Eurex: Buxl options: Bid/offer, carry and the buyside view.
An alternative for clients is to execute through an exchange-traded derivatives (ETD) broker. Traditionally, asset managers tend to trade through banks whereas hedge funds prefer to trade through an exchange broker, although it does vary from client to client.
“I think the majority of hedge funds will end up using an exchange broker and it will be the broker they are most familiar with. That way, they can get the broker to do the work for them and it gives them the opportunity to trade with a variety of market-makers and paper,” said one OTC dealer.
Moreover, the hedge funds that Total Derivatives has spoken to confirm they execute Buxl options through a broker.
As for the strategies that are being played out, the majority tend to be directional, such as call or put spreads. “In that regard it’s actually very similar to the OTC market, where the majority of sub-1y expires that trade in the market are directional plays such as payer ladders, receiver ladders, or it could be a payer spread versus a receiver, and so on,” said one OTC trader.
A trader at one hedge fund confirmed they would sometimes look to trade call spreads or put spreads in the Buxl option, as well as sometimes expressing a view that could protect the OTC book and provide some form of hedge.
Conclusion - A positive start
Piecing everything together, hedge funds and asset managers are seen as the most frequent users of the Buxl option, with OTC desks slightly more reluctant.
In the bigger picture, one trader was quick to point out that the Buxl option has seen a positive reception, particularly when compared to other product launches. “It’s been a surprisingly positive story. The launch of a new futures product is not an easy thing to do and the number of those that finish up with open interest and an order book on the screen (like the Buxl option) are very few and far between,” he said.
For more details on Options on Buxl Futures (OGBX) including contract specifications, please see Eurex factsheet.
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