Stoxx, a leading global index provider based in Europe, has introduced a new series of strategy indices designed to provide enhanced exposure to European equity market volatility.

Hartmut Graf, Chief Executive Officer of Stoxx.

The new indices, called the Dynamic VSTOXX Indices, seek to exploit opportunities that present themselves in the term structure, or forward curve, of European equity volatility futures.

Essentially, the indices aim to capitalise on the superior performance of short-term futures when the volatility forward curve is in backwardation (typically during stressed market environments) and of mid-term futures when the volatility forward curve is in contango (typically during normal markets environments).

To achieve this objective, the indices apply a dynamic allocation strategy to VSTOXX futures aimed at identifying the most rewarding – and, at the same time, less risk-prone – combination of short- and mid-term futures. The VSTOXX measures the implied volatility in EURO STOXX 50 option prices and provides a gauge of market expectations of volatility

The Dynamic VSTOXX indices follow an “index of indices” concept, meaning their value is calculated based on the value of two separate underlying indices, in this case the VSTOXX Short-Term Futures Index and the VSTOXX Mid-Term Futures Index. The weights of these underlying indices are rebalanced dynamically based on a ratio of their values. The VSTOXX Short-Term Futures and VSTOXX Mid-Term Futures indices replicate a hypothetical portfolio of a rolling investment made in various VSTOXX futures contracts.

Hartmut Graf, chief executive officer of STOXX, said the newly launched Dynamic VSTOXX indices “offer market participants the possibility to diversify their portfolio by adding exposure to VSTOXX futures.” He added: “Through the dynamic weight allocation between the two underlying VSTOXX Short- and Mid-Term Futures indices, which ranges from short to long positions, the index adapts to high and low volatility regimes in the European market.”

Two of the new indices, the straight Dynamic VSTOXX and Dynamic VSTOXX Net Of Costs (which additionally accounts for market costs associated with index replication), have already been licensed to Barclays, the UK investment bank, for an as-yet-undisclosed product.

Benedict Redmond, Director of Equity Derivatives Structuring at Barclays, said: “These new indices cater to the demand we’ve seen from investors looking to mitigate some of the downside risk of investing in many assets, whilst still wanting to reduce the cost of carry when conditions are more benign. The Dynamic VSTOXX indices may appeal to a wide selection of investors who like the negative correlation of the VSTOXX with equity markets, but who also want the longer-term hedge that these indices offer, rather than trying to time the volatility market.”

Both the Dynamic VSTOXX and Dynamic VSTOXX Net Of Costs indices are available in three different versions: Alpha, Long-only and Standard. While the Alpha version allows a short exposure to the VSTOXX Short-Term Futures of up to -50%, the Standard versions limits this to -30%. In the Long-only version, any short exposure to the underlying index is prohibited.

UK and European investors looking to access this kind of strategy right away are best to begin their search at Source, the London-based exchange-traded fund (ETF) provider. Although predominately based on US equity market volatility (i.e. the VIX Index), Source offers a number of products in the space including a pair of ETFs benchmarked to indices in the JP Morgan Macro Hedge Index series and a pair linked to the Nomura Voltage Strategy Index series.

Of particular note to European investors is the JP Morgan Macro Hedge Dual TR Source ETF (MHDU) which follows similar principles to the new Stoxx indices. This London-listed ETF provides exposure to US and European equity volatility by investing in VIX and VSTOXX futures according a strategy dependent on the shape of the forward curve. Essentially, the fund aims to capture spikes in volatility during stressed markets, while generating a positive return in normal market environments.