A month since the launch of the iboxx 50 index (ASR, 2/6/06), Europe launched its new cash-settled futures market that is meant to give investors and issuers cheaper access to risk and create more secondary liquidity.
"This is the massive, official launch for forwards contracts - where we've got the entire market involved," said one trader at BNP Paribas.
On the March 1 launch date, the contracts were trading at 99.96 to par for June. September trades were between 99.95 and 99.99.
The ABS-50 component bonds are determined to be the 50 most liquid bonds selected from the 70 largest tranches issued in the last year. But the index launched on Feb. 1 was initially not tradable.
"Essentially, the forwards are cash-settled, based on the difference between the strike price and the close price," said Chris Greener at the Royal Bank of Scotland. "The first series started a month early to provide some price history."
This first run of the futures settled contract has an extended length, from February to June. The first product run offers a future settled contract at three monthly intervals to coincide with the quarterly cycle of the index's rebalancing. The contract will take its final value on the 20th day of the settlement month. The new rebalanced index will begin on the 1st of the month, with the new and old indices running parallel for an additional three months. December, March, June and September are the normal settlement months going forward.
Futures contracts may prove valuable for triple-A investors or issuers seeking to lock in current spread levels or take exposure to spread direction.
"We anticipate early trades will include trading desks reducing exposure to market volatility on large positions," Greener said. "Issuers may also hedge spread volatility ahead of large transactions."
Triple-A spreads have exhibited extremely low volatility. According to figures reported by RBS covering the past three months of weekly spread data, one standard deviation would be less than one-half of a basis point for five-year U.K. prime RMBS. During the past year it was 1.8 basis points for prime U.K. RMBS while five-year CMBS spreads had a standard deviation of 1.2 and 2.8 basis points for three months and one year, respectively, based on indicative offering levels.
"One concern we have relates to market disruption' language, although the exact terms have not been finalized," Greener said. " Market disruption' would be defined if spreads move more than a specified number of standard deviations from the average over the period. This event would remove the hedge for tail-end risk that may reduce the hedging benefits for many investors."
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