Eurex is set to launch options on Euro-Buxl® Futures in September 2020, citing client demand for a product to address bond yield volatility at the long end of the curve. In a DerivSource Q&A, Lee Bartholomew, Head of Fixed Income Product R&D at Eurex and Thomas Bamford-Murphy, Head of LongEnd Options Europe at Maven Securities, discuss the benefits of this new volatility trading and risk hedging tool.
Q: Why launch Euro-Buxl® Options and why now?
LB: Yields on 30-year German bonds have declined steadily since 2008, dropping further following the 2012 Euro crisis and remaining low. The long end of the German yield curve benefited from the European Central Bank’s Quantitative Easing program, and investors turned to longer duration exposure in search of yield. Today, the 30-year point of the yield curve is the only remaining tenor that has a positive yield and is therefore actively traded with the use of Euro-Buxl®Futures.
Liquidity in the underlying Euro-Buxl® Futures has been increasing, with average daily volume reaching 78,000 in Q1 2020 – a 46 percent increase over the previous year – and open interest doubling in the past two years. In 2019, volume in Euro-Buxl® Futures averaged 60,000 contracts per day and open interest ranged from 200,000 to 300,000 contracts.
Volatility in the market has led investors to call for a new instrument with which to trade the volatility spread between different points along the German curve, or between the German and US 30-yr bond yield curve points. US 30-year bond yields have remained higher than those for German bonds since the Euro crisis, and price correlation between the two yields broke down following the US Federal Reserve’s tightening cycle in 2016 leading to increased volatility in the spread. Eurex’s new Euro-Buxl® Options product also enables investors to hedge risks from government bond auctions and to sell covered calls or to short volatility to enhance returns.
TM: From the market making side, we feel there is enough liquidity in the Euro-Buxl® Futures for us to try options in this space, and we’re confident we could hedge the Delta components of the options trades, which will allow us to provide liquidity in the options from day one. We should see that the offering of options increases the net interest in the product (BUXL). And as we then hedge these in the underlying, we should see this drives a little more liquidity. So there should be an uptick as we start to engage.
Q: What interest have you found from buy-side clients? Do you expect interest to increase? What are the drivers for buy-side clients?
LB: Buy-side firms are looking for an additional method for accessing and expressing a view on the long-term bond market. Increasing electronification since the global financial crisis, a growing buy-side preference for listed securities that can be cleared and settled easily, and pressure from passive management strategies means that active managers are always looking for additional ways to find alpha. Euro-Buxl®Options will be traded electronically via Eurex, which brings standardisation and straight-through processing advantages. Market makers are also expected to welcome the new products which will be fairly straightforward to add to their offering from a technical point of view.
“Buy-side firms are looking for an additional method for accessing and expressing a view on the long-term bond market. Increasing electronification since the global financial crisis, a growing buy-side preference for listed securities that can be cleared and settled easily, and pressure from passive management strategies means that active managers are always looking for additional ways to find alpha. Euro-Buxl®Options will be traded electronically via Eurex, which brings standardisation and straight-through processing.” – Lee Bartholomew, Eurex
Options on Euro-Buxl®Futures can also be traded outside the order book on a bilateral basis, and subsequently booked to Eurex Clearing through the use of Eurex T7 Entry Services (TES). Members are able to enter bilaterally agreed off-book transactions into the trading and clearing system. Registered off-book trades are then automatically cleared like regular exchange transactions. The minimum entry size for block contracts is 50 contracts.
Q: What trading opportunities can firms target with Euro-Buxl® options?
LB: While banks provide sufficient liquidity in the swaptions space, clients use options to hedge underlying portfolios, express curve views, express relative value views between certain parts of the curve or different tenors, different expiries and maturities.
Euro-Buxl® Options allow clients to express certain conditional curve views and to trade Europe versus US, for example. It enables the end customer to have something else when volatility strikes or rates change, such as during the pandemic. If there is significant two-way flow in the underlying space, this long part of the curve becomes very interesting, and could lead to good two-way flow in the options space.
“As a market maker, we are excited about Euro-Buxl®Options because they fit alongside what we do already and allow us to access liquidity in a space we couldn’t previously. They allow us to offset risks more efficiently, as well as to provide liquidity, which might not be currently available by offering prices and sizes in particular products based on the exposure that we’ve picked up in other correlated products.” – Thomas Bamford-Murphy, Maven Securities
TM: As a market maker, we are excited about Euro-Buxl®Options because they fit alongside what we do already and allow us to access liquidity in a space we couldn’t previously. They allow us to offset risks more efficiently, as well as to provide liquidity, which might not be currently available by offering prices and sizes in particular products based on the exposure that we’ve picked up in other correlated products.
Q: What are your expectations for growth in the coming year?
LB: The key to success will be the market makers getting comfortable and providing the right level of liquidity for the right size of risk. On the bank trading side, when liquidity dries up in certain parts of the curve, the end users’ appetite can sometimes outweigh the liquidity appetite of those that are providing the market. In this case, market makers have expressed their support and there is a broad mix of liquidity providers in order for them to focus on where they are comfortable. This product serves a genuine end customer need and we expect a positive launch.
TM: In our view Euro-Buxl® Options provide market makers with risk offsetting opportunities so they will all support it and want it to be a success. Each market maker does things a little bit differently, so it is good to have a slightly larger group with a slightly more differentiated way to look at and offset risk, especially in the early days, to ensure that initial liquidity. We’ve seen products very similar so we believe it would be a good product to add. It is a fairly easy addition from a technical point of view because it is electronic, and market makers are already connected to Eurex. I think market makers will build that liquidity and there will be strong interest.