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Equity derivatives: Volatility trading growth hit by lower liquidity

Investors stay on the sidelines and look at directionless strategies.

"The problem is that we’ve not just seen higher volatility but that volatility itself has been very volatile"

Abhinandan Deb, Barclays Capital

Volatility trading has been booming in recent years as hedge funds and a growing number of traditional fund managers have turned to volatility products, particularly variance swaps, for trading opportunities negatively correlated to equity markets. Aite Group, a consultancy, estimates that variance swap trading volume growth could hit more than 100% this year. The product, which trades volatility squared and is particularly useful for mapping the volatility profile that is typical in equity and equity index options, is the fastest-growing segment in the volatility swap product set. However, it is being hit by extreme market movements that have scared liquidity out of the market.

"The problem is that we’ve not just seen higher volatility but that volatility itself has been very volatile – this too has impacted liquidity in equity derivatives and other markets," says Abhinandan Deb, a volatility analyst at Barclays Capital. "Single stock variance swaps have been particularly affected because of a combination of factors. The introduction of short-selling restrictions created a lot of uncertainty about which stocks were affected.

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