2018-07-10

Risk-based futures

Financial Fiction Episode 3: Risk-based futures



For linear interest rate derivatives, risk and DV01 are considered as very similar expressions.

This is also what we can deduce from the name of the latest new futures launch by NASDAQ.

Some five years ago, I proposed a new design for interest rate futures that I called risk-based futures. I worked with ASX in 2014 to adapt the design for the AUD market. At the end of 2015, ASX launched a swap futures based on that design. The ASX product has an extra feature of having a variable tick value, but the central feature of the design is the same: a futures price representing a rate or yield and the physical delivery of an ATM trade on the futures expiry.

NASDAQ will be launching soon its DV01 Treasury Futures. According to NASDAQ, the new product will be available for trading on Thursday, July 19, 2018, pending regulatory approval.

The name "risk-based futures"(1) has been changed to "DV01 futures", but the central idea is the same: future style margin on the price multiplied by a conventional DV01/PVBP and physical settlement at expiry into an at-the-money trade.

In my generic design the delivery mechanism can take several variants. NASDAQ has selected the simplest one where the notional of the delivered trade is fixed in advance. This create a jump in risk at delivery. The risk jumps from the futures term-sheet DV01 (e.g. 850 USD by basis point for the U.S.10-yr DV01 Treasury futures) to the actual DV01 of the delivered instrument. The variant is to deliver at expiry a trade with a notional adapted to smooth the risk.

The design of the futures I proposed is very versatile. As mentioned above, ASX has proposed a version; the underlying is a BBSW swap. The NASDAQ is now proposing a version with US Treasury underlying. I have proposed a version for the overnight-indexed market. The overnight-linked market is expected to become more important with the increased importance of SOFR, SONIA and probably a new EUR overnight benchmark. I will publish the details of the OIS based version in the coming weeks.

Another financial fiction becoming reality! See Financial Fiction 1 and Financial Fiction 2.



(1) I used that name at the The 3rd Interest Rate Conference (London, UK) in March 2015 in a presentation with the title Deliverable Swap Futures: a risk-based design.

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