Can you arb a market if you can perfectly predict volatility?

Discussion in 'Strategy Development' started by fielman, Apr 30, 2007.

Can you trade futures to make expected (or riskless) profit with volatility foresight

  1. Yes, you can make an expected profit

    7 vote(s)
  2. Yes, you can make riskless profits

    1 vote(s)
  3. No, it is still a random walk

    6 vote(s)
  1. fielman


    If you have perfect foresight of the volatility (of a certain time-frime) of a particular market, say the S&P 500, is it possible to trade in a way to make an expected profit or even a riskless profit by only trading the futures market.

    Easy to make money using options, i'm talking about trading the underlying futures market only.
  2. wave


    yes. watch the deltas and ITMs, they will guide you to see the flow.
  3. nitro



    Of course! And your question regarding options as opposed to the underlying is irrelevant. The underlying can be thought of selling ATM put and buying ATM call and vice versa.

    You can also synthetically simmulate a treasury bill by a combination of risky assets!

  4. fielman


    nitro - if you go long a put and short call at the same strike you have a short future - and you miss the point because you are not long or short of volatility.

    If you you now that volatility is going to be greater than what implied volatilities on the options are indicating, you can make a riskless profit by going long options - delta neutral.

    My question is if there is a mathematically sound method to take advantage of your foresight of volatilty, not direction of the maket.
  5. nitro


    Uh, yeah. My point is there is no difference between "synthetic underlying" using options, and the underlying. I don't know why you want to restrict yourself to only being long or short the underlying, when you have the same effect synthetically by adding options to possible execution set, but have the choice of turning a directional trade into a vol trade.

    Yes. If the volatility is autocorrelated, whether MA(n) or ARIMA(n), and you know the instantenous vol (just take the IV of the corresponding ATM straddle), and you know the entire path of the realized vol by seeing the future vol, then you can increase your expentancy on a trade, even without using options and just buying/selling the underlying. In fact, probably you can know the exact price at each point in the future of the underlying since vol and price are related mathematically through Black Scholes etc.

    I understood your question the first time. I am just saying that trading is not "straightedge and compass only" construction problem

    You use the asset category that best fits your edge. If your edge is in better vol models than the market, then there is no more efficient way to take advantage of that than with options.

  6. fielman


    I'm not saying I have a superior vol model - just playing with ideas. Let's give you an example - the three columns below are the movements of an index over five days (three different series, and possibly a gazillion more possibilities).

    The three series are not correlated. The only thing that they share is the volatility over five days - being 40.

    1 -10 100
    5 40 100
    20 65 48
    21 -32 20
    100 -10 20

    If I tell you the movements will be either column 1, column 2, column 3 or their absolute version (eg (column 1) x -1 etc.), can you give me a trading strategy using only futures that will yield a profit irrespective of the 6 series of movements you will get?
  7. nitro


    Well now you have gone from perfect knowledege of future vol, to three (finite) realizations of it.

    This is a far deeper question, and I have to think about it. My intuition says yes, you can increase your expentancy if you tell me the column, and the values in each column are autocorrelated MA(n) or ARIMA(n) [or probably many other models as long as they are computable.]

    AFAIK, futures at the micro-structure level are MA(1), so you would have to arb it at the high frequency and have incredible commish and clearing costs, as well as probably a direct connection to the exchange.

  8. Nitro does not understand what you are talking about.

    You inquired:

    "If you have perfect foresight of the volatility (of a certain time-frime) of a particular market, say the S&P 500, is it possible to trade in a way to make an expected profit or even a riskless profit by only trading the futures market."

    We created a distribution invloving a market pace/volatility matrix. (For S&P futures)

    The the columns and rows EACH show normal (very low kurtosis) distributions.

    The movement of the market operating point on the matrix is by migration.

    We do not do targets since they are so limiting but if a person does, he can use S&P data to do riskless profit taking.

    The proof of this we constructed by using the data base in such a way that, effectively, the independent and dependant variables were reversed and trading was conducted without loss of performance. (the money velocity level (of profits) is many times higher than target trading strategies).

    It feels like and performs as though you are trading by reversing the direction of time in the context of how market volatility works over time and you are seeing the market movement as though you reversed the video of the data flow. (You "know" the data flow).

    You do not have to step out of the S&P futures nor do you have to "insure" it with additional types of other instruments and their respective correlations.

    There are four other essential aspects of markets that all interelate on this matter.