We all missed a trick. Did you realise it was possible to patent volatility? Nor did I, but apparently it was done 10 years ago.
Back in February 2000, Robert Krause filed a patent for a “computer implemented method for the creation and trading of financial instruments based upon the volatility of an underlying…” and called it a ‘volatility contract’.
Krause is an options veteran – he has been at Zurich Capital Markets, Mitsui Commodities, Morgan Stanley and the CME (Chicago Mercantile Exchange) – so he knows his options onions. He also knows a bit about patent law: the patent was granted (US patent no. 7,328,184 B1) and the CME has now licensed the product from Krause’s company The Volatility Exchange (VolX).
In the first quarter of 2011, CME will begin offering a set of realized or historical volatility futures. The FX VolContracts will be cash-settled to either a one- or three-month historical volatility, calculated by reference to daily price movements in major CME currency futures. “The FX VolContracts will be the first futures contracts that offer direct trading of foreign exchange volatility. In addition, they will provide spread trading opportunities against CME’s listed FX futures and options products,” says CME.
“These innovative new contracts provide our growing global customer base who trade FX the ability to express and manage volatility exposures in the currency markets with an effective cash settled product,” says Craig LeVeille, CME group director of FX products. “We know from talking to our global customer base that effectively managing risk between realized and implied volatility, correlation arbitrage, and hedging the volatility of their portfolios with currencies are vital. Offering these new VolContracts will help meet those needs.”
It sounds like an interesting idea, having an instrument that settles on realized rather than implied volatility. I’m not so sure if there is a demand for it; it should trade at the same level as forward-forward implied prior to the fixings and then as an amalgam of historical-to-date and implied. Perhaps just having an exchange-traded, volatility-only product is selling point enough.
If I sound less than enthusiastic, I apologise. I can’t stop thinking about an idea I had around 1980 for a thing where counterparties could exchange interest payment frequency – fixed for floating, for example. I should’ve gone down the patent office there and then to file an application for a patent on interest rate swaps.
If I had, I’d be writing this from my own private island.
