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Variance swaps and CBOE S&P 500 variance futures

04 Aug 2012

Article by: Lewis Biscamp and Tim Weithers
Published by: Chicago Trading Company, LLC
Date: ?

“Over the past several years, equity-index volatility products have emerged as an asset class in their own right. In particular, the use of variance swaps has skyrocketed in that time frame. A recent estimate from Risk magazine placed the daily volume in variance swaps on the major equity-indices to be US$5m vega (or dollar volatility risk per percentage point change in volatility). Furthermore, variance trading has roughly doubled every year for the past few years.

“Along with the proliferation of the breadth and complexity of available volatility products has come increased anxiety and confusion about how investors can most effectively and efficiently trade volatility. We offer a brief overview of the concept of variance and volatility; describe how a variance swap can be used to trade equity-index volatility; and illustrate some advantages that variance swaps offer over other volatility-based assets. Lastly, we will describe how CBOE variance futures contracts are essentially the same as an OTC variance swap.”

Full article (PDF): Link

 
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Posted in Implied volatility, Realized volatility, Trading ideas

 

A New Simple Approach for Constructing Implied Volatility Surfaces

19 Jul 2012

Article by: Peter Carr, Liuren Wu
Published by: NYU & Baruch College
Date: 2 Oct 2010

“Standard option pricing models specify the dynamics of the security price and the instantaneous variance rate, and derives its no-arbitrage implication for the option implied volatility surface. Market models start with an initial implied volatility surface and a diffusion specification for the implied volatility dynamics, and derive the no-arbitrage constraints on the risk-neutral drift of the dynamics. This paper proposes a new approach, which specifies the security price and the implied volatility dynamics while leaving the instantaneous variance rate dynamics unspecified. The allowable shape for the initial implied volatility surface is then derived based on dynamic no-arbitrage arguments. Two parametric specifications for the implied volatility dynamics lead to extreme tractability, as the whole implied volatility surface is determined by a quadratic equation. The paper also proposes a dynamic calibration methodology and calibrates the two models to over-the-counter currency option and equity index option implied volatility surfaces over an 11-year period. The model with lognormal implied variance dynamics generates superior performance over standard option pricing models of similar complexities. Furthermore, constructing implied volatility surfaces using our two models is 100 times faster than using traditional option pricing models.”

Full article (PDF): Link
Presentation (PDF): Link

 
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Posted in Implied volatility

 

Key Tools for Hedging and Tail Risk Management

09 Jul 2012

Published by: Asset Consulting Group
Date: Feb 2012

This article analyzes five benchmarks that are designed to provide protection during declining equity markets. It discusses their performance relative to equity indices, such as the S&P 500, and describes how they might be used to enhance returns and/or lower risk.

Full article (PDF): Link

 
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Posted in Trading ideas

 

Analysis of Carr and Lee’s Quadratic Variation Derivatives Framework

29 Jun 2012

Article by: Peter Larkin
Published by: Kellogg College, University of Oxford
Date: 18 Apr 2012

“Over the last years, there has been a growing interest in pricing and hedging financial products contingent on the volatility or variance of tradable assets. In parallel to this, there is a fundamental need to price in such a way as to capture all the information available in the market – in particular, in the observed implied volatility smile.

“The volatility of an equity is the simplest measure of how risky it is, or perhaps how much it is likely to move around in the future, based on how it has moved historically, or what the market implies it to be in the future. Investors may wish to trade volatility if they believe they have some insight into the level of future volatility. For example, if a trader thinks that volatility is currently too low, he or she may want to take a position which allows them to profit if volatility increases.

“In this work we are interested in a one important part of this growing area – the pricing and hedging or European options whose pay-off at maturity depends on the quadratic variation of the underlying process.”

Full article (PDF): Link

 
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Posted in Realized volatility

 
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