Is low volatility gone, or will it continue in 2018? Winners in the Derivatives categories are hedging their bets on which way the volatility pendulum swings in order to stay ahead of the game.

Author: Joel Kranc
Antoine Jacquemin 200
Jacquemin, Societe Generale: We have engaged in strategic discussions with clients regarding interest-rates risk management policy.

It is déjà vu all over again. In 2017, derivatives markets were influenced by the same drivers as the year prior: low volatility and regulations such as the European Market Infrastructure Regulation and the Markets in Financial Instruments Directive II, or MiFID II.

Antoine Jacquemin, global head of Market Risk Advisory and deputy head of Western Europe Corporate Sales (FX and Rates) at Societe Generale Corporate and Investment Bank, which won Best Derivatives Bank in the Interest Rate category (as well as the Equity Derivatives category), says 2017 was marked by central banks’ divergence on monetary policy. “The Federal Reserve hiked and progressively normalized its policy, while the European Central Bank remained on hold,” he says. “Long-term US dollar rates have headed higher since mid-2016 lows.”

Giving clients options in the midst of these divergences is how Societe Generale stays on top of the market, says Jacquemin. “We have engaged in strategic discussions with clients regarding interest-rate risk-management policy,” he adds. “We have assisted clients in adjusting their policy and rebalancing their fixed versus floating debt mix through interest-rate swaps.”

Stephane Mattatia, global head of the Macro Group at Societe Generale puts it this way: “Volatility is at the lowest level it has been since at least the 1970s…which is really exceptional, and for us, being a derivatives house, volatility is the most important fact [related to our success] in 2017.”

Societe Generale customers have played relative-value trades for a few years, according to Mattatia. “Because S&P volatility collapsed, investors and clients could short the S&P and have a good ‘carry,’ compared to other markets such as the Nikkei or euro stocks whose flows were heavier and volatility remained stable,” he explains. Mattatia says that correlations reached a low level in 2017, largely because of the newer environment of rising interest rates, which put pressure on some sectors more than others.

The combination of low volatility plus low correlations gave investors the opportunity to participate in correlation trades. Hedge fund and asset managers took advantage of this through Societe Generale dispersion trades (selling of options on an index against buying a basket of options on individual stocks).

By buying volatility on stocks and selling the index, investors bet that correlations would remain low. “This is exactly what happened in 2017,” adds Mattatia, “and we have seen massive flows of dispersion trades done by hedge funds.” Regarding dispersion, Societe Generale believes there is approximately €50 million ($61 million) Vega Risk of dispersion on the Euro Stoxx 50 and about €80 million Vega Risk on the S&P 500 dispersion. “It means that if index volatility drops by one point compared with single stock volatility,” explains Mattatia, “there is a profit of approximately €120 million in the pocket of dispersion players.”

The rebound of the S&P in 2018 changed this dynamic in terms of volatility trades, and Mattatia says it is unlikely that there will be a low volatility environment like last year’s for some time.

In 2017, Citigroup, which won Best Bank for Credit Derivatives, cut through the competition spurred by low volatility. Vikram Prasad, Citigroup’s head of Correlations and Exotic Trading, was quoted in the press as saying, “We’ve seen meaningful pickup in more structured and exotic trading business, and 2017 is the year when investors are doing more trades with structural complexity to meet their return hurdles.”


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