Variance Derivative Contracts for Volatility Hedging
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Solution Overview
Problem
Current standard derivative contracts do not provide investors with sufficient tools to hedge against greater than expected or less than expected volatility in an underlying asset.
Innovation Solution
Creating and trading derivative contracts based on the variance of an underlying asset, calculated as the average squared deviation of daily returns, with a system comprising a variance property module, dissemination module, and trading module to display and execute variance futures and options contracts.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Adaptability or versatility
If standard derivative contracts (options and futures) are used, then trading and hedging capabilities are provided, but investors cannot effectively hedge against unexpected volatility in underlying assets
Solution Approach 1:
The patent introduces a fundamentally new parameter for derivative contracts - variance (volatility) of the underlying asset - rather than using traditional price-based parameters. This allows investors to hedge against volatility itself, not just price movements. The variance derivative contract settles based on the actual variance of the underlying asset over a specified period, enabling direct volatility management.
2Reliability
If in kind settlement is used for traditional derivatives, then asset transfer provides clear ownership rights, but it is not possible or desired when underlying assets are abstract market indicators
Solution Approach 1:
The patent uses cash settlement as a copy or representation of the underlying asset's value. Instead of transferring the actual abstract asset (which is impossible), the system calculates and transfers a cash amount that represents the variance of the underlying asset. This cash copy enables settlement for abstract market indicators while maintaining clear transaction finality.
3Adaptability or versatility
If cash settlement is used for abstract assets, then trading becomes possible, but the settlement process becomes more complex compared to tangible asset transfer
Solution Approach 1:
The patent calculates the variance of the underlying asset in advance over the specified period before settlement occurs. This preliminary calculation of the statistical property simplifies the final settlement process, as the settlement amount is directly determined by the pre-computed variance rather than requiring complex post-trade analysis of abstract asset movements.
Data Source
AI summary
Methods and systems for creating and trading derivative contracts based on a statistical property reflecting a variance of an underlying asset are disclosed. Typically, an underlying asset is chosen to be a base of a variance derivative and a processor calculates a value of the statistical property reflecting an average volatility of price returns of the underlying asset over a predefined period. A trading facility display device coupled to a trading platform then displays the variance derivative based on the value of the statistical property reflecting the volatility of the underlying asset and the trading facility transmits variance derivative quotes from liquidity providers over at least one dissemination network.