Article by: Peter Carr and Dilip Madan
Published by: NYU
Date: 30 Jan 2002
“The primary purpose of this article is to review three methods which have emerged for trading realized
volatility. The first method reviewed involves taking static positions in options. The classic example is
that of a long position in a straddle, since the value usually increases with a rise in volatility. The second
method reviewed involves delta-hedging an option position. If the investor is successful in hedging away
the price risk, then a prime determinant of the profit or loss from this strategy is the difference between the realized volatility and the anticipated volatility used in pricing and hedging the option. The final method reviewed for trading realized volatility involves buying or selling an over-the-counter contract whose payoff is an explicit function of volatility. The simplest example of such a volatility contract is a vol swap. This contract pays the buyer the difference betweeen the realized volatility3 and the fixed swap rate determined at the outset of the contract.”
Full article (PDF): Link