Variance Swap Pricing via VIX Differential
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Solution Overview
Problem
Trading products like variance swaps settled to the CBOE Volatility Index (VIX) are difficult and expensive to manage, especially in terms of margin, due to the complexity and cost of trading VIX as a basket of listed options, leading to traders often divesting before expiration.
Innovation Solution
A system and method where a trading product's price or parameter, such as a variance swap's strike price, is defined as a differential to a reference product like VIX, allowing traders to buy or sell volatility at a set basis point above or below the VIX settlement price, enabling easier risk management and avoiding the need for large option positions.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Reliability
If traders take delivery of VIX as a basket of listed options, then they gain volatility exposure, but the complexity and cost of managing large option positions increases significantly
Solution Approach 1:
The patent extracts the essential function of VIX (volatility measurement) from its complex implementation as a basket of listed options. By creating a simplified volatility index product that delivers the same volatility exposure without requiring the full option basket, the invention removes the management complexity while preserving the core volatility exposure function.
Solution Approach 2:
The patent introduces an intermediary volatility index product that mediates between the complex VIX option basket and the trader's need for volatility exposure. This intermediary product serves as a simplified proxy that provides equivalent volatility exposure without requiring direct management of the underlying option portfolio.
2Reliability
If traders take delivery of VIX as a basket of listed options, then they gain volatility exposure, but the margin cost increases significantly
Solution Approach 1:
The patent extracts the volatility exposure function from the capital-intensive VIX option basket structure. By creating a streamlined volatility product that achieves the same exposure with reduced capital requirements, the invention eliminates excessive margin costs while maintaining reliable volatility exposure.
Solution Approach 2:
The patent creates a more cost-effective volatility exposure mechanism that replaces the expensive VIX option basket. The simplified structure reduces margin requirements and transaction costs, making volatility exposure accessible without the high carrying costs of the traditional approach.
3Loss of energy
If traders divest VIX before expiration to avoid costs, then margin issues are reduced, but the ability to maintain long-term volatility exposure is compromised
Solution Approach 1:
The patent enables continuous volatility exposure by creating a volatility index product designed for sustained holding. Unlike the traditional VIX basket that becomes prohibitively expensive over time, this invention maintains cost-effectiveness throughout the holding period, allowing traders to maintain exposure through expiration without forced liquidation.
Solution Approach 2:
The patent provides a volatility exposure mechanism that costs less than the traditional approach at all holding periods. By structuring the product to have lower ongoing costs, traders can maintain exposure longer than they would with VIX, effectively extending the duration of useful action through what amounts to a cost advantage.
Data Source
AI summary
Various embodiments are directed to a system and method for specifying a transaction for a product having a parameter such as price (e.g., strike price) defined with reference to a parameter (such as price) of another asset. In some embodiments, at least one processor may receive indicia indicating a trading product having a price defined as a differential to a reference product. At least one processor may determine a price of the reference product. At least one processor may calculate a price of the trading product by adding the differential to or subtracting the differential from the price of the reference product. The calculated price may be transmitted via a network to an output device.