Hi, what is the most effective way of doing a vol arb trade intraday? I put a few case scenarios and would only do these with weekly options in highly liquid stocks. I am also working from the basis of no stock and option commissions so let´s just see this from the technical point of view. 1. Selling the ATM straddle of stock X where the implied vol of the straddle is higher than one´s prediction of realized volatility for the day and continuously delta hedging the straddle. Closing the straddle at the end of the trading day. I am thinking that in this case, especially at the beginning of the week, there is unaccounted risk: vega. Every day, one filters for the stock that has the highest ATM weekly implied vol/ forecasted realized volatility and puts on the trade at the open and closes it at the close. Sizing is done based on THETA, so every day one looks for $1000 Theta. 2. Filtering for the highest ATM implied vol/forecasted realized volatility on a weekly basis. Therefore, let´s imagine that NFLX is pricing 42% implied ATM straddle on Monday. One´s forecast is that the realized volatility during the week will be 20% and this is the highest ratio of implied to realized that one can get on the highly liquid options. One sells 5 ATM straddles on Monday, let´s say the 335 weekly straddle, and delta hedges it continuously until the end of the day. The straddle and hedges get closed at the end of the day. Next day, Tuesday, one sells the same 335 weekly straddle which now prices 38% implied and one´s forecasted realized vol is still 20% and delta hedges it. At the end of the trading day, it gets closed. Next day, the same operation is done until the implied volatility converges to the realized volatility or the other way around or the close of Friday weekly expiration arrives. 3. Filtering for the highest ATM implied vol/forecasted realized volatility on a weekly basis. Everything is the same as in case scenario 2; however, one sells 5 ATM straddles on Monday which would be the 335 weekly straddle, delta hedges it and closes it at the end of the trading day and on Tuesday, one sells the new weekly ATM straddle which may be the 345 (NFLX opens at 345 on Tuesday). The only thing that has changed with case scenario 2 is the strike, which instead of fixing the ATM strike on Monday and delta hedging it until Friday or until the implied and realized volatilities converge, one puts on a new ATM straddle everyday, so if NFLX opens Tuesday 345, the new straddle is 345, if Wednesday is 330, the the straddle that is put is the 330 and so on. Which one is the most effective way of capturing the difference between the impied volatility and realized volatility? If none, please would you tell me the reasons why. Thank you very much in advance.
You need to sell a strip of options (eg. instead of sell five ATM straddles, sell 1 option in each strike) and dynamically hedge. (You can close the position at the end of day and reopen a new position the next day). However the cost (bid ask spread plus commission) of putting on the spread will probably be greater than any edge you have in mis priced options. So, a better way of putting on this trade would be to look for a strike which has a particularly high bid and selling 10 options on that strike.