Wilde Sapte has advised on an innovative financial deal which could open up trading in a new financial product – volatility.
Under the ground-breaking deal, fund manager Foreign & Colonial (F&C) bought an option on the volatility of the US Standard & Poor 500 index. The volatility was based on a futures contract traded on the Chicago Mercantile Exchange.
Volatility is the measure of the tendency of a share or a share index to vary over time. It is one of the components used in pricing an option or derivative. But in this deal volatility was treated as an asset in its own right for the first time.
The option was issued by NatWest Markets with the help of Wilde Sapte, as a “put warrant” on the Luxembourg Stock Exchange.
When it was issued in early-August the volatility of the S&P index was 13.5 per cent, unusually high since the index's historical volatility is 11 per cent. F&C reckoned volatility would decline by the time the warrant was exercised in mid-September. It paid a premium for the warrant and agreed that if volatility fell below 13.5 per cent it would get its premium back plus a certain amount from NatWest.
NatWest, on the other hand, took the view that volatility would increase by mid-September and agreed to pay back the premium, minus a certain amount, if this was the case.
Wilde Sapte partner John Walker and assistant Vincent Keaveny helped NatWest arrange the unique swap and the unusual put warrant.
Keaveny said: “The transaction was innovative in two ways: first in that it was a trade in volatility in its own right and second in the way it was listed as a put warrant. We had to list it because F&C's own investment criteria require that investments be in listed instruments.”
He said other banks would follow NatWest's lead: “Vol-atility is such a fundamental part of the pricing of any derivative transaction that it's only a matter of time before there are more transactions of this sort.”
“It's technically possible to document almost any derivative structure. Our clients main concern was taking it into the pubic domain with a listing. The Luxembourg stock exchange was very helpful.”