USRE43435E1 - Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility - Google Patents
Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility Download PDFInfo
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- USRE43435E1 USRE43435E1 US12/724,825 US72482510A USRE43435E US RE43435 E1 USRE43435 E1 US RE43435E1 US 72482510 A US72482510 A US 72482510A US RE43435 E USRE43435 E US RE43435E
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- G—PHYSICS
- G06—COMPUTING; CALCULATING OR COUNTING
- G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
- G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
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- G—PHYSICS
- G06—COMPUTING; CALCULATING OR COUNTING
- G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
- G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
- G06Q40/04—Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange
-
- G—PHYSICS
- G06—COMPUTING; CALCULATING OR COUNTING
- G06Q—INFORMATION AND COMMUNICATION TECHNOLOGY [ICT] SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES; SYSTEMS OR METHODS SPECIALLY ADAPTED FOR ADMINISTRATIVE, COMMERCIAL, FINANCIAL, MANAGERIAL OR SUPERVISORY PURPOSES, NOT OTHERWISE PROVIDED FOR
- G06Q40/00—Finance; Insurance; Tax strategies; Processing of corporate or income taxes
- G06Q40/06—Asset management; Financial planning or analysis
Definitions
- the present invention relates to the field of financial and negotiable instruments and exchanges that trade in such instruments, and more specifically to standardized financial instruments that are market-priced, purchased and sold, and that settle at a price that is based solely on the volatility of the underlying over a certain predefined period of time.
- instruments provide “formal expression to a legal act or agreement, for the purpose of creating, securing, modifying or terminating a right.” See Black's Law Dictionary, West, Revised 4 th Edition, 1968.
- an instrument Once an instrument is created, it can be purchased and sold. Since instruments have a term, one can bargain in the price. The instrument itself can be purchased and sold over time, and one can “observe” a price at any given point in time (if the instrument is standardized and is listed on a regulated or non-regulated exchange). The fluctuations between observations can be measured with a statistical standard deviation formula known as “volatility.” The instrument itself can be called an “underlying,” when there are instruments that derive their value from it. Volatility is an absolute value, since it is the amount of change, rather than the upward or downward direction of that change.
- Volatility between observations can be determined after the observations have occurred. Such historical viewing can provide the data necessary for a calculation of historical volatility.
- the risks associated with future volatility can be the subject of a bargain, themselves being purchased and sold, and thereby assisting the assumption or minimization of risk.
- prior to the invention herein there has been no effective standardized mechanism by which a tradable instrument captures the future (realized) volatility of an underlying, in which the instrument has a term, observations during that term, an annualized figure, and wherein final settlement of such an instrument can coincide with the settlement of the options on the underlying.
- Risk is a key element in every business and financial decision, and its presence, dictated by the unknown that the future might bring, has been the basis by which the financial markets have prospered. Participants in these markets have been able to reduce or increase their risk by trading instruments that capture price changes in existing markets for such trading. However, participants have heretofore been unable to obtain exposure to changes in the level of that risk by way of standardized instruments.
- Multi-national corporations looking closely, may find that in addition to directional risk they really have large amounts of volatility risk.
- Hedge fund managers and commodity trading advisors could easily use a new asset class to base new, uncorrelated trading programs. And, exchanges are always looking for new products that could enhance volume.
- U.S. Pat. No. 6,016,483 to Rickard, et al. shows a method and apparatus for automated opening of options exchanges.
- Formulation and trading of risk management contracts is shown in U.S. Pat. No. 5,970,479 to Shepherd.
- Analysis of derivative securities is shown in U.S. Pat. No. 5,692,233 to Garman.
- a game concerning financial futures is shown in U.S. Pat. No. 4,588,192 to Laborde.
- Negotiable instruments are patentable, as shown by U.S. Pat. No. 6,014,454 to Kunkler (see, e.g., claims 32 through 44).
- Volatility Contract (“Vol”) has been designed to be an exchange-tradable instrument similar in many ways to a futures contract.
- Volatility Contract, Vol Contract, Vol and all combinations, including abbreviations, of associated contracts with a specified time frame are trademarks of Event Capital Management Corp. (www.eventcm.com). Use is by permission only.)
- a Vol is based on the fluctuations of prices, or volatility in prices, over a certain time period. In other words, it is based on the realized or actual volatility that the underlying instrument displays.
- Trading in the instant instruments will significantly assist market participants in reducing the volatility risks of the underlying.
- a Volatility Contract can be created on any market, and that such creation will fall within the spirit and claims of the subject invention.
- Vol Contracts are the missing link in the current realm of exchange-traded derivatives. It is generally recognized that futures trade based only on direction of the underlying, while options trade based on both direction and volatility of the underlying. Vol Contracts would trade based purely on volatility. Such Contracts should give rise to a plethora of hedging methods, speculative strategies, and arbitrage opportunities. As shown herein, Vol Contracts overcome the pitfalls in prior attempts to trade volatility. Such prior attempts have been in error in trying to make the underlying predictive, instead of making it the item to be predicted.
- a Volatility Contract is an exchange-tradable financial instrument. Volatility Contracts would settle to a calculated value of market return fluctuations over some designated time frame. To quantify these price fluctuations, the invention coins a calculated term known as realized volatility. Realized, historical, actual, and future volatilities all refer to the same concept: the fluctuations in price level of the underlying over a period. The only difference is whether the period occurs in the past (historical volatility), the future (future volatility), or non-specified (realized or actual volatility).
- a Vol therefore, is a regulated or non-regulated exchange-tradable instrument that would settle to the realized volatility of a specific underlying, over a specified period of time, regardless of the exact formula used to measure the volatility or the sampling period employed.
- Volatility Contracts in accordance with the subject invention can be based on any underlying. Essentially, if a futures or an option could be traded on an asset or instrument, then a Vol could as well. For example, Bridge/CRB identifies close to 700 active futures markets all over the world. There are presently five equity options exchanges, and about fifty exchanges that trade in options through the world. Volatility Contracts could be made available on any or all of them or on any yet-to-be-listed derivatives market. Also, any listed stock, unlisted stock, physical commodity, physical asset, basket, index, currency, currency swap, treasury instruments, interest rates, market indices and commodities, and the like are all potential candidates.
- Vol is similar to a futures contract, where market participants try to determine the final expiration value during much of its life.
- the contract's value would become more and more certain as final settlement approaches.
- Trading a Vol while in the realized volatility period can be considered similar to the manner in which agricultural futures now trade in the delivery month. In other words, the Vol Contract would cease to be a pure anticipatory vehicle during its realized volatility period.
- FIG. 1 is a systematic overview of the stages of creation and trading of the financial instrument in accordance with the subject invention
- FIG. 2 is a graphical comparison of three volatility contracts having a different term against futures and options
- FIG. 3 is a graphical representation of the term structure of volatility
- FIG. 4 is a graphical representation showing price differentials based upon root mean squared and mean of volatility contracts.
- FIG. 1 shows the four key elements of the method and system of the instant invention.
- box 2 is directed to the creation of Vol Contracts based upon Realized Volatility, the time during a trading period that observations “t” are taken, an annualization factor “P”, a formula for the calculation of Realized Volatility, and an identified exchange for listing the contract for trading.
- Vol Contracts are traded on the exchange as shown in box 4 , during the anticipatory period, and a price determined by the market.
- Trading continues during the realized volatility period shown by box 6 , during which the market determines the price, and information necessary to determine Realized Volatility becomes more known as the time approaches expiration of the contract.
- Trading thereafter continues and eventually ends at box 8 when expiration occurs.
- all open contracts settle to the calculated value of Realized Volatility. This is the final settlement price for the contract.
- Delta hedging also called delta-neutral hedging, is a dynamic process of neutralizing directional market exposure by trading in the underlying according to a schedule determined by an option pricing model.
- the OTC options market is estimated at $13 trillion (exchange-traded options would be in addition to that figure). While this product is designed for regulated or non-regulated exchanges, much of this OTC option risk should find Vol contracts useful in reducing this volatility risk. Neuberger [1994] stated that “ . . .
- Speculator are another group of users. Employment of the instant Vol contracts will provide hedge fund managers and commodity trading advisors with a whole new asset class on which to base trading programs. Individual speculators that now presumably use straddles and strangles to “buy volatility” or “sell volatility” will be able to gain direct volatility exposure.
- the profit/loss profile is linear (unlike an option);
- the realized volatility period for Vol Contracts and the delivery month for commodities are periods for which both Vol Contracts and futures cease to function as true anticipatory vehicles;
- the contract value is based on a calculation of the underlying's period price returns over a specific time frame, not just one final price at expiration;
- the performance bond might be different for long and short positions.
- Vol Contract While a standard option's terminal value is based on the underlying's price on the day of expiration, Vol Contract in accordance with the preferred embodiment, are based on the realized volatility of the underlying over many days. In a way, a Vol Contract's expiration value is similar to that of an exotic option known as an Asian option (or Average Rate Option), traded in over-the-counter markets, where the final settlement price is determined by averaging several intermediate settlement prices.
- Asian option or Average Rate Option
- the preferred formula is different in that it has a zero mean.
- Vol 3 would actually be a good match. For example, if the first 45 days yielded a realized volatility of 10%, and the next 45 days turns out to be 15%, then the average is 12.5%.
- trading two contracts would give one the same dollar exposure to an expected increase in volatility. In reality, one would not just simply average the values but use a root mean squared formula. The formula is different, but the concept is the same, as shown in FIG. 5 .
- Vol is quoted in annual percentage terms.
- the contract multiplier should be multiplied by the number of months of the realized volatility period. If, for instance, Japanese yen Q-Vol were last traded at 11.22% (0.1122), and the contract multiplier were $100,000, then this Volatility Contract would be valued at $33,660 ($100,000 ⁇ 0.1122 ⁇ 3 months). If a Japanese yen M-Vol were traded at the same price of 11.22%, then its value would be $11,220 ($100,000 ⁇ 0.1122 ⁇ 1 month). Multiplying by the number of months might aid spreads and arbitrage between the different Volatility Contracts. The contract size would also correspond more closely to the smaller options premiums, as expiration approaches. The month multiplier would add little confusion among participants. Such a design would lead to more potential use by option traders. Also, the variability of volatility is greatest with shorter times. Therefore, longer-term contract can have larger notional values without the threat of tremendous volatility changes.
- the minimum price fluctuation for financials could be 0.01% (0.0001). If the contract multiplier were $100,000, then the minimum tick size would be $10 for an M-Vol and $30 for a Q-Vol. For agricultural markets, the minimum may be 0.05% (0.0005) for M-Vol and Q-Vol. If the contract multiplier were $10,000, then the minimum tick size would be $5 for an M-Vol and $15 for a Q-Vol. An A-Vol could have the same 0.01% minimum as the financial markets, giving it a $12 tick size.
- the performance bond in percentage terms should be higher than for futures contracts in general. Also, it may be prudent to charge different performance bond levels depending on whether the market participant is long or short (options have such a long/short differential).
- the Vol contract should be listed when the underlying futures or options are listed.
- Table I shows trading and calculation of a Vol in accordance with the preferred embodiment of the invention.
- Volatility Contract has been designed to be an exchange-tradable instrument based on volatility. It can be created on any instrument with linear characteristics (e.g., futures, stock, index, currency, etc.). It will provide a way for market participants to speculate on, or hedge against, changes in perceived market risk (volatility).
- the Volatility Contracts will trade in a manner similar to a futures contract in that market participants will be trying to forecast a future value. Unlike futures contracts, though, a Vol will settle to a calculated value of an underlying over some predetermined time frame (called the Realized Volatility period), as opposed to just the value at the end of the period. A Vol will settle to the underlying's realized volatility. It should expire when the corresponding options expire.
- the Realized Volatility period some predetermined time frame
- Implied Volatility An index of volatility that incorporates Implied Volatility has many drawbacks. It could be easily manipulated. It appears to have been designed with only market makers in mind—but fails to accommodate them. It requires market participants to estimate a future estimation—an intangible result. Previous attempts have tried to list options before a liquid, tradable underlying was available. All of these problems are solved with the Vol as taught herein, which, in addition, should appeal to a broader array of market participants.
Abstract
Description
Svol={Rt
wherein:
-
- Svol≧0
- n>1
and
- t=each of a series of observation points from 1 to “n”;
- Rt=return of the underlying based upon each of the observation points in time “tn”; and
- n=total number of observations within the term.
The term is selected from the group consisting of days, months, quarters and years. The settlement price is annualized based upon an approximate total number of periods in a calendar year. The observation points are taken daily, and approximate total number of periods is selected from the group consisting of 245 to 262, and preferably 252. Rt is selected from the group consisting of:
wherein:
- Mt=mark-to-market price at time “t”; and
- Mt−1=mark-to-market price at the time immediately prior to time “t”, at time “t−1”
The settlement price is determined in accordance with the following formula:
wherein:
- P=approximate number of trading periods in a calendar year, and each observation point “t” is taken at the same time, and
-
R =mean of all Rt's.
Where:
(each Rt is the continuously compounded return for one time period)
Ln=Natural logarithm
Mt=Mark-to-market price
Mt−1=Mark-to-market price one period prior to the above
n=Number of observations
t=An index to count each observation up to the maximum at n
P=Number of periods in a year
The variables in this formula are as stated hereinabove. The advantages are as stated. Additionally, it should be observed that this formula is simpler, and such simplification would help to promote widespread use.
Claims (50)
$100,000×Volatility×Number of Months.
$100,000×Volatility×Number of Months.
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US12/724,825 USRE43435E1 (en) | 2000-02-15 | 2010-03-16 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
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US09/505,947 US7328184B1 (en) | 2000-02-15 | 2000-02-15 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
US12/724,825 USRE43435E1 (en) | 2000-02-15 | 2010-03-16 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
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US09/505,947 Reissue US7328184B1 (en) | 2000-02-15 | 2000-02-15 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
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US09/505,947 Ceased US7328184B1 (en) | 2000-02-15 | 2000-02-15 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
US12/724,825 Expired - Fee Related USRE43435E1 (en) | 2000-02-15 | 2010-03-16 | Financial instruments, system, and exchanges (financial, stock, option and commodity) based upon realized volatility |
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US20120054084A1 (en) * | 2010-08-27 | 2012-03-01 | Wolf Brian M | Delta Neutral Futures Allocation |
US20130031023A1 (en) * | 2011-07-29 | 2013-01-31 | Rixtrema | Generating updated data from interrelated heterogeneous data |
US8671049B1 (en) | 2012-11-07 | 2014-03-11 | Thong Wei Koh | Financial system and method based on absolute returns |
US20170109822A1 (en) * | 2014-03-21 | 2017-04-20 | ITG Software Solutions, Inc | Network communication system for exchange trading |
US9710854B2 (en) | 2013-12-19 | 2017-07-18 | Chicago Mercantile Exchange Inc. | Volatility based futures products |
US20180276759A1 (en) * | 2017-03-27 | 2018-09-27 | Swiss Reinsurance Company Ltd. | Adaptive, self-optimizing, leveraged capacity system and corresponding method thereof |
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