Method and system for creating and trading derivative investment products based on a statistical property reflecting the variance of an underlying asset

• US 20070106583A1
• Filed: 10/10/2006
• Published: 05/10/2007
• Est. Priority Date: 05/04/2005
• Status: Active Grant

• Current Assignee: Cboe Exchange, Inc. (Cboe Global Markets, Inc.)
• Original Assignee: CTC Trading Group, LLC
• Inventors: Hiatt, John, Shalen, Catherine
• Granted Patent: US 8,326,716 B2
• Time in Patent Office: Days
• US Class Current: 705/35
• CPC Class Codes: G06Q 40/00 Finance; Insurance; Tax strategies; Processing of corporate or income taxes
• CPC Class Codes: G06Q 40/04 Trading; Exchange, e.g. stocks, commodities, derivatives or currency exchange

Abstract

A system and method for creating a limited risk derivative based on a realized variance of an underlying equity is disclosed. In one implementation, a limited risk derivative product includes a capped value for a statistical property reflecting a variance of the underlying equity is calculated based on a pari-mutuel action. The capped value comprises a dynamic value and a cap. The dynamic value reflects an average volatility of prices returns of the underlying equity over a predefined period of time and the cap reflects a maximum value of the dynamic value. The limited risk derivative product additionally includes an average of a summation of each squared daily return of the underlying equity included in the value for the statistical property reflecting the variance of the underlying equity.

Claims

1. A limited risk derivative product based on a realized variance of an underlying equity, comprising:

a capped value for a statistical property reflecting the variance of the underlying equity, the capped value for the statistical property comprising a dynamic value and a cap, the dynamic value reflecting an average volatility of price returns of the underlying equity over a predefined time period and the cap reflecting a maximum value of the dynamic value; and

an average of a summation of each squared daily return of the underlying equity included in the value for the statistical property reflecting the variance of the underlying equity;

wherein the value of the statistical property is calculated according to the formula;

$\mathrm{Realized}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{Variance}=A<br><br>\text{\hspace{1em}<br><br>}<br><br>F\times <br><br>\left(\underset{i=1}{\overset{N_a-1}{\sum <br><br>}}<br><br>R_i^2/\left(N_e-1\right)\right)$$\mathrm{wherein};<br><br><br><br>R_i=\ln <br><br>\text{\hspace{1em}<br><br>}<br><br>\frac{P_{i+1}}{P_i},$

P_i is an initial value of the underlying equity used to calculate a daily return, P_i+1 is a final value of the underlying equity used to calculate the daily return, N_e is a number of expected underlying equity values needed to calculate daily returns during a variance calculation period, N_a is an actual number of underlying equity values used to calculate daily returns during the variance calculation period; and

AF is an annualization factor.

2. The limited risk derivative product according to claim 1, wherein the capped value comprises a squared deviation of a daily return of the underlying equity that is removed to correspond to a market disruption event.

3. The limited risk derivative product according to claim 1, wherein the underlying equity is selected from the group consisting of:

equity indexes or securities;

fixed income indexes or securities;

foreign currency exchange rates;

interest rates;

commodity indexes; and

commodity or structured products traded on a trading facility or over-the-counter market.

4. The limited risk derivative product according to claim 1, wherein the capped value is a result of a parimutuel auction.

5. The limited risk derivative product according to claim 1, wherein the product is a variance futures product.

6. The limited risk derivative product according to claim 1, wherein the product is a variance options product.

7. The limited risk derivative product according to claim 6, wherein variance options product is a limited risk option contract.

8. The limited risk derivative product according to claim 7, wherein the limited risk option contract comprises a contract payout that is a capped variable amount.

9. The limited risk derivative product according to claim 7, wherein the limited risk option contract comprises a payout that is a constant amount when the value of the underlying asset is in a specified strike range at expiration and zero when the value of the underlying asset is outside the specified strike range.

10. The limited risk derivative product according to claim 7, wherein the limited risk option contract comprises a combination of a long call option comprising a contract payout that is a capped variable amount with a short put option comprising a contract payout that is a capped variable amount, both the long call option and the short put option having the same strike prices and option premium prices.

11. A method of creating limited risk derivatives based on a realized variance of an underlying equity, comprising:

calculating from a pari-mutuel auction a capped value for a statistical property reflecting the variance of the underlying equity, the capped value comprising a dynamic value and a cap, the dynamic value reflecting an average volatility of price returns of the underlying equity over a predefined time period and the cap reflecting a maximum value of the dynamic value;

calculating an average of a summation of each squared daily return of the underlying equity included in the value for the statistical property reflecting the variance of the underlying equity;

wherein the value of the statistical property is calculated according to the formula;

$\mathrm{Realized}<br><br>\text{\hspace{1em}<br><br>}<br><br>\mathrm{Variance}=A<br><br>\text{\hspace{1em}<br><br>}<br><br>F\times <br><br>\left(\underset{i=1}{\overset{N_a-1}{\sum <br><br>}}<br><br>R_i^2/\left(N_e-1\right)\right)$$\mathrm{wherein};<br><br><br><br>R_i=\ln <br><br>\text{\hspace{1em}<br><br>}<br><br>\frac{P_{i+1}}{P_i},$

P_i is an initial value of the underlying equity used to calculate a daily return, P_i+1 is a final value of the underlying equity used to calculate the daily return, N_e is a number of expected underlying equity values needed to calculate daily returns during a variance calculation period, N_a is an actual number of underlying equity values used to calculate daily returns during the variance calculation period; and

AF is an annualization factor;

displaying at least one limited risk variance derivative based on the statistical property reflecting variance on a trading facility display device coupled to a trading platform; and

transmitting at least one limited risk variance derivative quote of a liquidity provider from the trading facility to at least one market participant.

12. The method according to claim 11, further comprising:

displaying at least one limited risk variance derivative based on the statistical property reflecting variance on a trading facility display device coupled to a trading platform; and

transmitting at least one limited risk variance derivative quote of a liquidity provider from the trading facility to at least one market participant.

13. The method according to claim 12, wherein calculating the value of the statistical property reflecting the variance of the underlying equity comprises:

removing the squared deviation of a daily return of the underlying equity that corresponds to a market disruption event.

14. The method according to claim 11, further comprising:

executing trades for the limited risk variance derivative by matching bids and offers to buy and sell positions in limited risk variance derivatives.

15. The method according to claim 11, wherein the underlying equity is selected from the group consisting of:

equity indexes or securities;

fixed income indexes or securities;

foreign currency exchange rates;

interest rates;

commodity indexes; and

commodity or structured products traded on a trading facility or over-the-counter market.

16. The method according to claim 11, wherein at least one of the at least one limited risk variance derivative is a limited risk option contract.

17. The method according to claim 11, wherein at least one of the at least one limited risk variance derivative is a limited risk futures contract.

18. The method according to claim 11, wherein the trading platform is an open outcry platform.

19. The method according to claim 11, wherein the trading platform is an electronic platform.

20. The method according to claim 11, wherein the trading platform is a hybrid of an open outcry platform and an electronic platform.

21. The method according to claim 11, further comprising:

transmitting the at least one limited risk variance derivative quote from the trading facility over at least one dissemination network.

22. The method according to claim 21, wherein the dissemination network is the Options Price Reporting Authority.

23. The method according to claim 11, wherein the trading facility is an exchange.

24. The method according to claim 12, wherein the liquidity provider is selected from the group consisting of:

Designated Primary Market Makers (“

DPM”

), market makers, locals, specialists, trading privilege holders, members, and a registered trader.

25. The method according to claim 12, wherein the market participant is selected from the group consisting of:

a liquidity provider, a brokerage firm, and an investor.