Podcast: Zetocha on mini-futures (not those) and illiquid options
Julius Baer equity quant revels in solving problems for the trading desk

Valer Zetocha’s job as head of quantitative services for equity and foreign exchange at Julius Baer occasionally takes him to some of the more remote corners of the market.
Most recently, he was asked to devise a pricing methodology for so-called mini-futures. While most will be familiar with the popular e-mini futures listed by CME, mini-futures are a type of leveraged derivative, with an embedded barrier that effectively works like a stop loss mechanism. They are mostly traded in Germany, as well as Switzerland.
Dealers guarantee the barrier in the contract, and could be exposed to significant hedging losses in the event of large and sudden price moves. This risk is particularly elevated when company earnings or important economic data – such as inflation prints – are released.
They may not be the most glamorous or widely traded product, but mini-futures present real problems for dealers. Getting the pricing wrong can be extremely costly. “If there’s mispricing, you may be looking at losses of the order of the whole year of P&L for that particular underlying,” says Zetocha.
Zetocha’s solution, published in Risk.net in January, deals with the gap risk in mini-futures. Because the gap risk of long mini-futures resembles that of deep out-of-the-money put options, they can be priced similarly. “The solution is taking the periodic perpetual nature of the mini-future and writing a valuation equation for the gap risk” in order to estimate the probability and the magnitude of the negative P&L when the spot drops through the barrier.
In this podcast, Zetocha also discusses his solution for building the volatility surface of options written on illiquid assets, or liquid options with some maturities or strikes that are scarcely traded, which was published in Risk.net last October.
This is another very common problem for dealers that want to offer a price on those options without exposing themselves to the risk of being arbitraged by other dealers.
Zetocha’s method is an algorithm that fills in the gaps where price and volatility metrics are not available. In essence, it starts by bootstrapping the volatility levels from the liquid strikes and then applies a formula designed to optimise certain metrics in a statistical distribution to fill in the data gaps.
Index:
00:00 Intro and the mini-futures market
06:54 Mini-futures pricing and risk management
18:43 A pricing model that accounts for gap risk
23:00 Volatility surfaces and illiquid strikes
28:32 Completing the volatility surface
35:17 How a quant finance project gets started
To hear the full interview, listen in the player above, or download. Future podcasts in our Quantcast series will be uploaded to Risk.net. You can also visit the main page here to access all tracks, or go to the iTunes store, Spotify or Google Podcasts to listen and subscribe.
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