Volatility Derivatives in Practice: Activity and Impact

Abstract

We use unique regulatory data to examine open positions and activity in both listed and OTC volatility derivatives. Gross vega notional outstanding for index variance swaps is over USD 2 billion, with dealers short vega in order to supply the long vega demand of asset managers. For maturities less than one year, VIX futures are far more actively traded and have a higher notional amount outstanding than S&P 500 variance swaps. To the extent that dealers take on risk when facilitating trades, we estimate that the long volatility bias of asset managers puts upward pressure on VIX futures prices. Hedge funds have offset this potential impact by actively taking a net short position in nearby contracts. In our 2011‐2014 sample, the net impact added less than half a volatility point, on average, to nearby VIX futures contracts but added between one and two volatility points for contracts in less liquid, longer‐dated parts of the curve. We find no evidence that this price impact forces VIX futures outside no‐arbitrage bounds.

Keywords: Variance swap, VIX futures, options, demand pressure, buying pressure

JEL Classification: G13, G12