As a number of recent news stories have commented on Swaptions Clearing, I decided to look into this topic.
The first question we need to answer:”Is there sufficient trading activity in Swaptions to allow it to be successfully cleared?”.
So lets look at the data in SDR View, starting with USD Rates products traded on a single day, June 28th.
- From this we see that after USD Swaps FixedFloat, Swaptions are the second highest volume product.
- Swaps of type Basis and OIS have lower volume and yet are already cleared.
- FRA are cleared and on some days have volumes as large as Swap Fixed Float but on other days less than Swaptions.
Now lets look at USD Swaptions trade counts by week over the past two months.
- We can see that weekly volume of trades is in the 550 to 850 range, or 110 to 170 daily.
Looking at a table of Gross Notionals.
- We can see that weekly volume is greater than $45 billion.
- Large block trades dominate as capped notional is four times more than standard notional.
- So actual weekly volume is likely to be far higher and as an estimate at least $100 billion.
So we can safely answer the our question, “Is there sufficient trading activity”, with an unequivocal, “Yes there is”.
And why is this important?
Because trading activity and volumes are a sign of market liquidity and for a CCP to clear products it needs to rely on liquid market prices; both for daily variation margin and for initial margin.
So while liquidity is not the only test, it is the most important one.
Other questions that we may want to consider are:
- Are most swaptions traded with standard terms and conditions?
- What is the volume split in terms of strike, expiry and tenors?
- Volatility smile and skew, are these observable to allow sound mark to market prices for strikes/expirys/tenors that are not the current most traded ones?
- Are option strategies (straddles, strangles, butterflies, ..) a major part of Swaption trading and how would this impact margining?
- Does Delta-hedging of Swaptions with Swaps mean that there are significant cross-margin benefits?
- Should the same Default Fund as Swaps be used or a separate fund created?
The discussion and answer to these, is one for another day and another article.
For today, we can say that there is sufficient trading and liquidity in USD Swaptions for these to be eligible for clearing.
You can see this for yourself by using SDR View and selecting the product as Swaptions.
We can also surmise that Swaptions are the next big product for competition between major CCPs.
The winner is likely to greatly benefit from this as well as an uptick in its share of Swaps clearing.
We live in interesting times.