Eurex will introduce variance futures based on the EURO STOXX 50 index this September, with hopes of breathing life back into a market that has significantly diminished post-financial crisis.
The OTC market for variance swaps traded around €50 million vega notional per day before the 2008 financial crisis hit, with that figure now reduced to around €0.5 million in Europe.
Eurex will hope the standardised contract, which will be traded and cleared on-exchange, will generate a resurgence in the use of the instrument.
The futures will replicate the pay-off profile of a variance swap using a daily-margined futures contract.
Instead of a final settlement payment upon expiry, the pay-off profile of a variance swap is calculated as the sum of all variation margin payments through the period the contract is held.
In line with regulatory mandates to bring more transparency to the swaps market, OTC derivatives are now subject to a series of new requirements, which have increased the cost of execution.
Eurex is looking to capitalise on this push with its new variance futures contract, the latest in a string of new launches the German exchange has initiated this year.
The Deutsche Borse-owned venue launched FX futures earlier this month and has also outlined plans for a swap futures contract later this year.
”Feedback from clients in the major financial centres of Europe has been exceedingly positive and we believe that a listed variance futures product has the potential to increase the size of the current market,” said Eurex executive board member Mehtap Dinc.
“Furthermore, this new product marks another evolution of the Eurex product range in response to client demand and market needs.”
In order to launch the contract, Eurex struck an agreement with DRW Innovations, which owns the US patent on variance futures methodology used by CBOE in the US.
CBOE lists its own variance futures based on the S&P500, however the contract has failed to gain traction since its December 2012 launch.
Eurex said it has already gained support from clients and believes the product will be a success due to banks and the buy-side having a contract they can trust.
“We feel this product will thrive in the European markets, offering greater liquidity and price transparency as well as easier access to centralised clearing," said Don Wilson, founder and CEO of DRW.