Method for trading and clearing variance swaps
In accordance with the principles of the present invention, a method for trading and clearing a volatility or variance-defined, standardized derivative financial instrument is provided. A financial instrument in either volatility or variance terms is negotiated. The realized variance to date on an underlying of that derivative financial instrument is determined. After the derivative financial instrument is negotiated and the realized variance to date is determined, at least one centrally-cleared financial instrument with a price derived from the volatility or variance terms and the realized variance to date on the underlying of that derivative financial instrument is delivered. Thus, a financial instrument negotiated in either volatility or variance terms is substituted with an equivalent position in a standardized, centrally-cleared financial instrument.
1. A method for trading and clearing a standardized financial instrument comprising:
negotiating a derivative financial instrument in either volatility or variance terms;
electronically determining the realized variance to date on an underlying of that derivative financial instrument on at least one processor; and
after the derivative financial instrument is negotiated and the realized variance to date is determined, delivering at least one centrally-cleared financial instrument with a price electronically derived from the volatility or variance terms and the realized variance to date on the underlying of that derivative financial instrument on at least one processor;
whereby a financial instrument negotiated in either volatility or variance terms can be substituted with an equivalent position in a standardized, centrally-cleared financial instrument.
2. The method for trading and clearing a standardized financial instrument of claim 1 further including electronically determining on at least one processor a payoff from the volatility or variance on the underlying of the derivative financial instrument.
3. The method for trading and clearing a standardized financial instrument of claim 2 further including utilizing at least one processor to electronically deliver at least one centrally-cleared financial instrument with a payoff determined from the realized variance over a predetermined time period.
4. The method for trading and clearing a standardized financial instrument of claim 1 further including, if the time period between the trade date and the expiration date can be covered by one standardized financial instrument, delivering one standardized financial instrument.
5. The method for trading and clearing a standardized financial instrument of claim 1 further including, if the time period between the trade date and the expiration date cannot be covered by one standardized financial instrument, delivering a series of standardized financial instruments that cover the time period.
6. The method for trading and clearing a standardized financial instrument of claim 1 further including, if the trade is negotiated in terms of volatility strike, converting the volatility strike into variance points taking into account of the realized variance already accrued to date in the standardized financial instrument.
7. The method for trading and clearing a standardized financial instrument of claim 6 further including, if there is no realized variance accrued on the date of the trade, determining the variance point as the volatility strike squared.
8. The method for trading and clearing a standardized financial instrument of claim 6 further including, if there is realized variance accrued on the date of the trade, determining the variance point in accordance with:
252
N
e
-
1
*
(
volatility
strike
2
*
(
N
e
-
1
-
n
)
252
+
∑
i
=
1
n
R
i
2
)
,
where
R 1 , . . . , R n are the n periods of return already realized; and
N e the total number of business days in the accrual period of the standardized financial instrument.
9. The method for trading and clearing a standardized financial instrument of claim 1 further including, if the trade is negotiated in terms of notional Vega, converting the notional Vega into variance units in accordance with:
Dollar
Vega
2
volatility
strike
*
100
*
N
e
-
1
N
e
-
1
-
n
,
where N e is the total number of business days in the accrual period of the standardized financial instrument, and n is the number of periods of return already realized.
10. The method for trading and clearing a standardized financial instrument of claim 1 further including determining final settlement price (F T ) in accordance with:
F
T
=
Realized
Variance
-
k
0
-
∑
t
=
0
T
-
1
(
F
t
-
C
)
×
R
t
×
B
t
.
T
365
+
C
where,
k o is a variance strike;
R t the Effective Federal Funds rate on day t;
B t,T , accumulation factor, equals
(
1
+
R
t
365
)
(
1
+
R
t
+
1
365
)
…
(
1
+
R
T
-
1
365
)
;
C is a predetermined constant added to the price in order to keep it in a preferred range, for example, non-negative region; and
t=0 is the first day the financial instrument has open interest.
11. The method for trading and clearing a standardized financial instrument of claim 1 further including determining daily settlement price (F t ) in accordance with:
F t =DF ( t,T )( k−k o )−ARMVM+C,
where
DF(t,T) is the discount factor from time t to maturity T according to the appropriate discount curve;
k is the quoted variance strike to the settlement price; and
ARMVM is the so-called accumulated return on modified variation margin.
12. The method for trading and clearing a standardized financial instrument of claim 1 further including delivering a volatility or variance-defined, standardized swap.
13. The method for trading and clearing a standardized financial instrument of claim 1 further including delivering a volatility or variance-defined future.
14. The method for trading and clearing a standardized financial instrument of claim 1 further including a price electronically derived from the volatility or variance terms, the realized variance to date on an underlying of that derivative financial instrument, and factors selected from the group comprising the number of days remaining accrual period, number of days into the accrual period, accumulated return on modified variation margin, and combinations thereof.
15. A method for trading and clearing a standardized financial instrument comprising:
negotiating a derivative financial instrument in either volatility or variance terms;
electronically determining the realized variance to date on an underlying of that derivative financial instrument on at least one processor; and
after the derivative financial instrument is negotiated and the realized variance to date is determined, displaying at least one centrally-cleared financial instrument with a price derived from the volatility or variance terms and the realized variance to date on the underlying of that derivative financial instrument;
whereby a financial instrument negotiated in either volatility or variance terms can be substituted with an equivalent position in a standardized, centrally-cleared financial instrument.
16. A method for trading and clearing a standardized financial instrument comprising:
negotiating a derivative financial instrument in volatility terms;
electronically determining the realized variance to date on an underlying of that derivative financial instrument on at least one processor; and
after the derivative financial instrument is negotiated and the realized variance to date is determined, delivering at least one centrally-cleared financial instrument with a price derived from the volatility terms and the realized variance to date on the underlying of that derivative financial instrument;
whereby a financial instrument negotiated in volatility terms can be substituted with an equivalent position in a standardized, centrally-cleared financial instrument.
17. A method for trading and clearing a standardized financial instrument comprising:
negotiating a derivative financial instrument in variance terms;
determining the realized variance to date on an underlying of that derivative financial instrument on at least one processor; and
after the derivative financial instrument is negotiated and the realized variance to date is determined, delivering at least one centrally-cleared financial instrument with a price derived from the variance terms and the realized variance to date on the underlying of that derivative financial instrument;
whereby a financial instrument negotiated in variance terms can be substituted with an equivalent position in a standardized, centrally-cleared financial instrument.
18. The method for trading and clearing a standardized financial instrument of claim 16 further including electronically determining on at least one processor a payoff from the volatility on the underlying of the derivative financial instrument.
19. The method for trading and clearing a standardized financial instrument of claim 17 further including electronically determining on at least one processor a payoff from the variance on the underlying of the derivative financial instrument.