Whilst the beginning of this growth trend does not perfectly coincide with the introduction of the PVM, an enhancement of quotation capacity in this trading segment at the end of 2020 fueled this development, as it enabled the liquidity providers and ultimately also the PVM to operate with greater technical efficiency. This led to a 42.4% increase in active warrants in fifteen months (with periodic drops owed to triple witching days). While market factors such as increased market volatility and trading activity have been growth-favorable, the introduction of the PVM appears to be a key factor driving growth in the warrants portfolio.
PVM Impact on Spreads
The PVM was introduced in a way that liquidity providers do not have to actively validate their quotes if they do not wish to do so, and can switch to active validation at any time. Consequently, when comparing the quoting behavior under the PVM with the firm pricing model, we consider the individual switchover dates of liquidity providers.
To analyze spreads before and after the switch to the PVM, we segmented the available price data along two dimensions. First, we divided the warrants into six buckets according to the price at which the warrants trade, then we segmented each bucket into five different volatility ranges of the SMI Volatility Index VSMI (based on the one-month implied volatility of the SMI stocks and is expressed in percentage) to reflect volatility in the underlying markets, and finally, for each cross-section, we derived the relative spread (“spread”) expressed as a percentage of the mean price.
The Chart 2: Relative Spreads by Price and Volatility Bucket displays the results for both periods, pre- and post- PVM, with the background color helping visualize the magnitude of the change in relative spread within a price bucket. Before the introduction of the PVM, the relative spread widens with increasing volatility while shrinking with increasing price.
However, under the PVM – which effectively removes price risk for the liquidity provider – we observed that spreads remain broadly constant across most volatility levels. With respect to whether spreads are tighter under the PVM, the answer is both “yes” and “no”. At low volatility levels, spreads are the same or even wider under the PVM, whereas, at higher volatility levels, spreads have tightened.