Calculate my hedge against volatility

Discussion in 'Options' started by heech, Apr 30, 2009.

  1. heech


    Hey guys,

    Thought I'd turn to the experts for a little advice. :) My strategy (confirmed in backtesting) is bearish in vol, and will gets killed when vol spikes suddenly.

    My strategy runs 30 calendar days (~20 trading days) at a time, so I'm only talking about hedging over that time frame.

    If actual realized volatility after 30 days is double (+100%) what of implied volatility was at the start of m cycle, I lose 10%. If it's +150%, I lose 15%, etc...

    If realized volatility is less than double of implied volatility, the hedge doesn't need to pay me anything.

    I'm not referring to vol for a specific symbol... we can deal with "broad market" (perhaps small-cap index? or just SPY) volatility.

    So, how do I hedge against this? What do I buy? What are the symbols in IB? What would be my cost?

    Thanks in advance!
  2. heech


    Hey folks,

    Turns out it's not that hard to figure out at all. VIX options are trading with an IVM of about 85% 30 days out...

    So if I buy front month calls at 55 strike (currently VIX at 35), I'll be paying 0.15 a contract.

    If VIX spikes up to 55 in the next 2 weeks, the calls will be worth at least 3.75 (and probably more due to higher IV). 25x gain on each contract.

    So, If I want to hedge against drop in value of 10% of my total portfolio, I'll need to pay 0.4% in cost every month. I'm happy with that.
  3. If it's so easy to figure out, why did you get it wrong?

    One piece of advice for you: do not trade VIX options - you obviously do not understand them.

    These are European style options. They can trade dollars under parity. So, if VIX = 55, the 55 calls can still trade at 10 cents. Why? Because the ONLY price that counts for those options is the settlement price for VIX, and that's determined when the options expire.

    They are not worth 'at least 3.75'

  4. heech



    My plan was to sell the options (not exercise them) 15 days into the trade, and 15 days before expiration. My option calculator came up with 3.75 as call price with underlying=strike at 55, IV at 90%, days until expiration=15.

    What am I missing?
  5. heech


  6. heech


    I've read that front-month VIX futures tend to move about 1/2 as fast as spot prices on a quick move up.

    I guess I just have to take that into account. I think this can still work, just going to cost me twice as much as I had hoped.
  7. heech


    Is anyone familiar with the VIX binary options?

    I have zero experience with these as well, but just intuitively... especially with front month options... I'd expect these options to be more volatile, and move more in line with spot prices even 15-30 days out.
  8. heech


    Hmm, I guess what I really want is a variance swap. It's only for a couple of weeks, so maybe I could implement it using a strip of SPY options.

    But I'd really like to just *buy* a variance swap.

    Are there any sellers of variance swaps to retail customers...?
  9. There are variance swaps futures ( VT ) traded on CFE.
  10. heech


    Interesting... this does seem to be what I'm asking for. But I'm still very new to this, so I'm still not sure about the implications...

    VIX futures don't work for my purposes, because the underlying is implied volatility *at expiration*...

    VT futures are a measure of actual volatility achieved... if achieved volatility = implied volatility after 15 days, I have no gain/loss on the future contract at all.

    But I'm not clear on the implications of a futures contract as a hedge... the futures contract is essentially vega = 1.

    If realized volatility is *lower* than implied... if realized volatility is zero... then it's canceling out the positive gains of my strategy.

    What I really want is a call option on the VT futures, yes?
    #10     May 2, 2009