Investors who want large-sized cash-settled index tools that can help manage global equity risk are exploring use of listed options on the MSCI EAFE® Index (ticker MXEA) and on the MSCI Emerging Markets Index (ticker MXEF).
NEW DEVELOPMENTS FOR MXEA AND MXEF OPTIONS
Recent new developments include:
1. NEW LEAD MARKET MAKER. On June 12 Cboe Options Exchange issued a notice stating that the exchange is “pleased to have selected Susquehanna Securities” as the Lead Market Maker (LMM) in the Regular Trading Hours (RTH) session for the MXEA and MXEF index options.
2. NEW LAST DAY OF TRADING AND MORE EXPIRATIONS. The June 12 Cboe notice also stated that, subject to the effectiveness of a regulatory filing, the last day of trading for an expiring series will be changed to the close of business on the last trading day (usually a Thursday) immediately prior to the expiration date. In the future the Exchange “plans to list up to 4 End-of-week expirations upon effectiveness of the rule change.”
3. CHINA A-SHARES. As noted in a 2017 Cboe blog, this month MSCI is beginning partial inclusion of 226 China large-cap A shares in the MSCI Emerging Markets Index. Inclusion at a 5% initial weight could lead to approximately $22 billion of capital inflows into these stocks. A blog by MSCI noted that “The China A shares that will be partially included to the index — large-cap mainland Chinese stocks that are traded domestically — will be added in two phases: half of their 5% initial weight will occur May 31, while the balance will be added in August. … The initial inclusion will boost China’s proportion of the index by only 0.8%, to 31.3%, based on current values.”
VOLATILITY RISK PREMIUM FOR MXEF & MXEA
Many options investors are aware of the fact that there usually has been a volatility risk premium (with implied volatility higher than realized volatility) for S&P 500 options over the past few decades, and I often am asked if there has been a volatility risk premium for other options on other stock indexes.
The two charts below do show that 30-day implied volatility at 95% moneyness usually has been higher than 3-trading day historic volatility over the past three years for both the MXEF and MXEA indexes; the average spread was about 8.4 volatility points for the MXEF Index and 5.7 volatility points for the MXEA Index.
The implied volatility for the MXEA Index hit peaks of 32.4 in late June 2016 (around the Brexit vote), and 35.5 on February 5, 2018.
VOLATILITY SKEW CHART FOR MXEA AND MXEF OPTIONS - DEMAND FOR PORTFOLIO PROTECTION
The volatility skew chart below for MXEF and MXEA options shows that the implied volatility for out-of-the-money (O-T-M) put options (at 80% and 90% moneyness) was much higher than the implied volatility for at-the-money options (at 100% moneyness). Risk-averse investors often are willing to pay a premium for O-T-M index options, and more money managers have been selling cash-secured index put options in recent years.
KEY FEATURES OF MXEF & MXEA OPTIONS
Key features of the global index options include —
· Efficiency with large contract size – cash-settled options on the MSCI indexes have a $100 multiplier and a notional size that is about 26 times larger than the options on the EFA and EEM ETFs.
· Simplicity – achieve broad-market exposure in one trade, as options on MSCI options offer investors tools with the potential to adjust exposure to the global markets at a fraction of the cost of buying individual stocks and ETFs
· Cash settlement – with no unwanted delivery of stocks or ETFs
· Predetermined risk for option buyers – option purchasers risk only the premium they pay for the option. The risk is both known and limited.
· European-style exercise – which protects option sellers against assignment prior to expiration (so-called “early assignment”)
- Expirations - Cboe offers options on the MSCI indexes with standard expirations and also offers FLEX options on MSCI indexes.In the future the Exchange “plans to list up to 4 End-of-week expirations upon effectiveness of the rule change.”
OPEN INTEREST FOR MXEA AND MXEF OPTIONS AT CBOE
Both of the next two charts show that the open interest for both MXEA and MXEF options has grown since early 2017, and the recent developments at Cboe highlighted above are designed with the goal of boosting open interest and liquidity in future months.
COUNTRY WEIGHTS AND GLOBAL DIVERSIFICATION WITH THE MSCI INDEXES
In recent decades the MSCI EAFE Index has been one of the most popular indexes for managing and gauging global equity markets exposure. On May 31 the MSCI EAFE Index had 923 constituent stocks.
The MSCI Emerging Markets Index captures large- and mid-cap representation and has 845 constituent stocks at the end of last month.
For more information on managing global risk and on Cboe’s options on the MXEA and MXEF indexes, please visit www.cboe.com/MSCI.