Hedge IV of SPX Put with VIX Option - possible?

Discussion in 'Options' started by ben111, Dec 8, 2009.

  1. ben111



    is it possible to hedge the increase (or decrease) of a SPX put's implied volatility with a VIX option?
    Eg. SPX Jan 1050 put - what VIX (call) option do you have to take to hedge any IV increase of the SPX put (if indeed such a hedge is possible).

    Thanks a lot
  2. MTE


    It's not that easy. It's like using an SPX put to hedge a fall in one of the component stocks. There is correlation so you should be able to hedge some part of the IV change, but it's far from perfect.
  3. so if you are short the put, and looking to hedge away the vega I would probably just make it into a put spread or buy a same strike call and make it into a synthetic stock...if you're only concern is hedging the vega. I assume that is not the case, so without more information it is difficult to really tell you because I personally do not think it would be a perfect hedge, correct me if I am wrong. I would assume you can just look up the vega of your option and buy a vix call with an equivalent vega and expiration but it doesn't seem like a perfect hedge to me because a vix option is the volatility of the volatility index which includes the volatility of your option so it just seems to get way too complicated and might not be a perfect hedge.
  4. ben111


    I did some backtests and "it's really far a way from a perfect hedge" and therefore I thought that I missed something.
    So no chance to hedge the IV increase of a SPX put? :-(
    Or is it easier to hedge the IV of atm SPX puts with VIX options or doesn't the put strike matter?

    Edit: Or is it possible to hedge it anyhow dynamically?
  5. ben111


    Hi GRG,

    changeing the put to a synthetic stock or put spread whould change the payoff and also delta/theta.
    My intention is to hedge the vega of a short calendar otm put spread - long front month and short back month put. For the last months it happened that always the implied volatility of the short back month put increased and therefore I'm interested in hedging that risk. Or is there any dynamic hedge possible?

  6. MTE


    VIX uses multiple strikes and expirations to arrive at the value so it's not a good approximation for a single strike. VIX options are priced off of futures rather than the spot VIX so that adds another dimension (complication).

    Your particular put's IV is affected by the general level of IV in that expiratio, its position on the skew (OTM, ATM, ITM) as well as the supply/demand for it.

    As I said, you may be able to partially hedge the change in IV using VIX options, but if you want a better hedge then use SPX options, but then you would be obviously changing the profile of your position. However, this is the way it works, if you want something hedged then you need to pay for it in one way or the other. The better the hedge the lower the potential return.
  7. ben111



    Thanks for your reply.

    I'll try to do it per SPX Options but I think it won't work :-(
  8. hlpsg


    I don't think you're hedging the Vega risk of the position so much as you're trying to hedge the risk from the volatility skew between the front and back months?

    I think you're basically long gamma and doing some kind of gamma scalping trade, so just off the top of my head, if you want to hedge the skew risk you'd need to sell some front months and buy some back months. I can't think of any long gamma strategy at the moment that does that but it could be an idea to think on.

    I don't know how you're going to quantify the risk from the skew though, in order to neutralize it, I don't think Vega correctly quantifies skew risk does it?
  9. ben111



    Sorry for the delayed answer.

    I don't want to hedge the vol risk between the two months. At the expiration of the front month only the back month implied volatility matters. Is it higher than at entry the payoff is worse than modelled :-(

    Is there any way to compare VIX options with SPX options (eg. SPX vega <-> VIX delta, ...)? Or are they just two different underlyings and you can't compare their options?
  10. To price your vix hedge reliably you will need a vvol input. Further, given that forward iv[VIX] consistently overprices iv, you are going uphill hedging in that manner.
    #10     Dec 10, 2009