Editorial
How good is FX volatility data and where do we source it
Many questions arise as to how to access and interpret FX volatility market data for both live data and historic data. Let me provide an overview what is going on in the industry.
Generally, we need to accept that the FX Options market is predominantly an OTC market. The number of FX Options traded on exchanges is still comparatively small. Therefore, FX volatilities are hard to access. A trader working at a hedge fund probably has the best chance of sourcing high quality data and comparing between different sell-side suppliers.
What is good FX volatility market data? Criteria would include but is not limited to the following list.
- Completeness: if we need to build a volatility surface ourselves we need at least: spot, a term structure of forward or swap rates, deposit or money market rates for both currencies, volatilities with smile information in the form of at-the-money (ATM), risk reversals (RR) and butterflies (BF) for 25- and 10-delta pillars, or volatilities for a set of delta pillars. In order to process this information, one also needs to know the conventions the vendor uses to quote these volatilities, including forward or spot delta, premium in- or excluded delta, Black-Scholes or smile delta.
- Documentation: all conventions used in producing the market data must be documented and the documentation must be accessible to the users.
- Free of outliers: dataset should be cleaned and must not contain obvious errors such as outliers or error messages.
- Synchronous data sets: all the data should ideally be taken at the same time. What happens very often is that a quote stays in the database until there is a new trade or a quote replaces the previous one. Especially for less liquid currency pairs and longer tenors’ quotes for volatility data can be outdated by several weeks.
- Time stamp: It must be clear at which date and time and time zone the data set is obtained.
- Tradability: Ideally the data source should arise from traded contracts or from bid-and offer quotes for contracts that would have been tradable. Aggregated data from various suppliers is typically generated by (weighted) averaging and is consequently not considered tradable.
- Independently verifiable data: It must be ensured that all users get the same data and that an independent data inspector can verify this. Unfortunately this is not always guaranteed.
- Logging: Asking for the same data set later in the future should return the same data as at a previous data query time. Unfortunately, this is not always guaranteed.
- Accessibility: Even the best market data is worthless if we can’t access it.
- Price: Ideally market data comes at a reasonable price.
I am not sure if this list is complete, but looking at all of these requirements, we already notice quickly that we need to abandon the idea that there is one and only one market price / volatility for an FX option, even a vanilla option, leave alone exotics – even today.
Now let us take a look at what’s out there:
- Common data vendors for FX volatilities include Reuters, Bloomberg, and SuperDerivatives.
- Banks’ electronic trading platforms provide implied volatilities in matrix form or any strike upon request.
- Brokers include ICAP, GFI, Tullett Prebon Information.
- Markit’s Totem service aggregates volatilities from and for the club of market makers.
- Upcoming data vendors aggregate the volatilities of the market making banks’ platforms.
In Detail:
- Looking at common data vendors, the data is normally not tradable. Technically, one can trade an FX option via Bloomberg or SuperDerivatives, but I have not met anybody who does it, simply because a simple telephone call to the bank will usually yield a better price. Moreover, neither the data sources nor aggregation procedure are documented. SuperDerivatives does not use 10-delta volatility information, but seems to calculate it from ATM and 25-delta volatility information. All the common providers are high-priced. A full table of OVDV in Bloomberg showing a lot of volatility information does not tell the user how liquid or current the quotes actually are. What can we realistically say about a 10-delta butterfly for a 10Y EUR-ILS contract?
- Banks’ electronic trading platforms have grown a lot over the last 10 years, and all the market makers offer them to their clients. They include UBS’ neo (formerly UBS trader), Barclays’ Barx, CS’ Merlin, Deutsche Bank’s Autobahn, etc. The tradability of options on these platforms has made the independent vendors’ platforms less important over the years. After all, one doesn’t expect much more than a tradable price. However, it is only the buy-side that benefits from these, i.e. professional traders in asset management and the hedge fund industry, as well as smaller or regional banks that the big market makers don’t consider competitors. An individual or a second-tier bank typically doesn’t have access to these platforms.
- Brokers’ volatilities tend to be clearer in the sense that they are sourced from actual quotes or trades. Here the problem is typically to get a synchronous data set. Furthermore, there are regional specialists one needs to include if one requires a full set of volatilities for many currency pairs.
- Markit’s Totem service is a daily aggregation and averaging of market makers’ volatilities. This is high quality data, however, only club members can see the aggregated results, and only if a member’s contributed volatility isn’t considered an outlier. The data is not publicly accessible, not even for a fee. Furthermore, while the volatilities represent the sentiment of the market, they are by construction not tradable.
- More recent attempts in the industry rest on a proprietary aggregation of market makers’ volatilities from electronic trading platforms. One can sign up and trade vanilla options via best execution. While current market data (non-tradable) can be obtained every 5 seconds, in the form of volatilities on the delta space, a typical problem we face still is that synchronous data for forward, deposits or FX swaps are not yet available.
Summary
Common FX volatility data providers remain opaque, require distinct individual processing (conventions, interfaces), quotations are aggregated and usually not tradable.
Realistically, tradable options are only available via market makers’ platforms, accessible by buy-side, mainly regional banks, asset managers, hedge funds. However, they are still used as indicators; trades are often done via telephone – still.
Aggregated market data of tradable volatilities is produced as EOD by Markit’s Totem, but only for contributing market makers (with outliers removed).
There exist recent solutions to making market makers’ volatilities available in aggregated form, but the corresponding data for FX forwards/swaps is not available from the same source.
Upshot: Either FX volatilities are good, free, but not accessible to those who need them, or: accessible, but expensive and of questionable quality.
Stay tuned to the editorial of July 2017 for follow-up examples of how to treat available market data to construct a volatility smile using interpolation and extrapolation.
Uwe Wystup, Managing Director of MathFinance
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