Kokou Agbo-Bloua, Managing Director, Global Head of Flow Strategy & Solutions from Societe Generale spoke about uses for longer dated options today at CBOE’s Risk Management Conference in Switzerland. His session was titled, More Value to Long-Dated Options than Meets the Eye. I was particularly interested to hear his talk since shorter dated options seem to be getting all the attention these days.
The talk began noting that when comparing long-dated and short-dated options there are distinct differences. He noted that a long-dated option may be thought more of a multi-asset portfolio of parameters or Greeks. Another factor he noted that caught my attention is that longer dated options can reduce the mark-to-market volatility of positions. It seems that many market participants believe a higher volatility regime is upon us so this thought may be put to use.
A slide that seemed to peak the audience’s attention depicts a credit/equity cycle as moving in a circular motion from deleveraging to co-recovery to re-leveraging to debt crisis. On this diagram the EU is shown to be between co-recovery and re-leveraging, the US is between re-leveraging and debt crisis, and China is between debt crisis and deleveraging.
He addressed volatility further and showed an 8-year term structure chart of S&P 500 implied volatility versus Euro Stoxx 50 volatility. The shape of the SPX curve is the normal contango we normally see with VIX (not these days though). The Euro Stoxx 50 term structure was opposite and in backwardation, but flattening farther out on the curve. The feeling is that in time the S&P 500 volatility term structure will flatten some. He was generous enough to allow use of the slide below to give a better picture of these two curves.
Volatility Term Structures - Courtesy Societe Generale
A final exercise embarked upon in this presentation involved projecting a long term outlook for the equity market and determining the best bull call spread to purchase based on this outlook. His example projected 8% growth with 15% standard deviation. A curve was developed using just purchasing long dated calls and then the risk / reward of a wide variety of call spreads was plotted with the best long dated call spread highlighted. The takeaway was that call spreads offer better returns than purely purchasing a call. What I particularly liked about this exercise was that wide variety of potential strategies that can be created with combining two calls that share an expiration date.