Over the next few weeks there is going to be a lot going on at CBOE. The Options Institute will be turning 30 soon, VIX and SPX option hours are going to be expanded to a 2:00 am Chicago opening, and the always informative US version of the CBOE Risk Management Conference will be held in early March. However, what is on the horizon that has me the most excited is the launch of index option trading on two of the widely followed MSCI family of indexes.

As a side note - my interest in new product launches is part of my job, but is also the subject of my PhD dissertation. I am enrolled in a program at Oklahoma State University working toward a PhD in Strategic Management. My main area of study is on the development of new listed derivative markets.  The launch of index options on the MSCI EAFE Index and MSCI Emerging Markets Index that is currently in the works is going to give me a real time look at the launch of a new product. Over the next few weeks I’m going to blog in this space as the launch of these options approaches and after they start trading at CBOE.

One of the assumptions of my studies is that a market needs to have sufficient volatility in order to attract traders. In this blog I’m going to take a look at the volatility of the MSCI EAFE Index. For those that are not familiar with the EAFE Index, it basically represents all developed markets outside North America. Yesterday I learned that there are over 900 components in the EAFE Index and that index performance represents about 85% of the market capitalization of the countries covered by the index.

Most market participants divided asset classes in the US between large cap and small cap stocks. The most active option markets representing these asset classes are the S&P 500 (SPX) for large cap stocks and the Russell 2000 (RUT) for small cap stocks. Since there is already a very active option market for both SPX and RUT, I am going to do a little comparison between those two markets and EAFE.

With all new markets that have an underlying index we can take a look at the history of that index. In the case of EAFE I’m going to compare the average monthly realized volatility by year for EAFE, SPX, and RUT along with the annual performance of each index. There is data going back decades for each of these indexes, but I chose to start with January 2008 for this comparison. This start date was not picked because it incorporates the Great Financial Crisis of 2008 – 2009, but due to the availability of the data set in the second example in this blog. The point is I’m not data mining and if you want to see comparisons going back to the 80’s I’m more than happy to share that data.

The chart below displays the rolling 21 trading day realized annualized volatility for the MSCI EAFE Index, S&P 500, and Russell 2000. They are grouped together by year and the bars appear in the order listed in the previous sentence. Each bar shows the maximum, minimum and average realized volatility by year.   Notice that international developed markets experienced more volatility than both the US large and small cap sectors over a short time period in 2008.  I find that interesting since conventional wisdom is that the crisis started in the US.  Also note that in general the type of volatility that occurs in the EAFE Index is very similar to the type of realized volatility that occurs for the S&P 500 and Russell 2000.

Annualized EAFE, S&P 500, and Russell 2000 21-Day Rolling Volatility


What is special about EAFE relative to many other new option market launches is that we actually have access to sufficient historical implied volatility data. CBOE calculates in real time the CBOE EFA ETF Volatility Index (VXEFA) which is based on the implied volatility of options that trade on the EFA exchange traded fund. In addition we have data going back to the first day of 2008 for VXEFA, hence the 2008 start date above and below. It should be expected that index options based on the EAFE index will share the same implied volatility characteristics as options that trade on an ETF designed to mirror that index. Going with that assumption I compared VXEFA, VIX, and RVX in the same manner as above.  In the chart below the high, low, and average levels for each of these volatility indexes are displayed by year and again in the order listed above.

 VXEFA, VIX, and RVX Price Behavior by YearVXEFA VIX RVX

In general the implied volatility for EFA options is very comparable to VIX and RVX. I would be very surprised if EAFE Index options do not display the same sort of price behavior as options on the EFA exchange traded fund. There are years where VXEFA has been higher than US market implied volatility and years where it has been lower. But again, it’s pretty similar and option traders should be comfortable with the price behavior of EAFE Index options.

This is the first in a series of blogs discussing the lead up to the launch of MSCI Index options. Other topics I’ll cover include implied versus realized volatility, expected hedging uses of these contracts, and cross trading opportunities. If you have an idea you want me to explore, now or after the launch, please shoot me an email – rhoads@cboe.com. In the meantime feel free to visit the following sites if you want to learn more about MSCI Indexes and related volatility –

MSCI – www.msci.com CBOE Page on MSCI Indexes - www.cboe.com/msci CBOE Page on EFA ETF Volatility Index (VXEFA) - www.cboe.com/vxefa CBOE Emerging Markets ETF Volatility Index Options - www.cboe.com/vxeem