Vega is correlated with spot price. However, "hedging" that creates basis risk. In your examples: 1. buying VIX means you will take the view that the roll down in VIX futures will be < your theta/gamma profit. You are betting that if there is a big move in realized vol, your VIX will rally to account for it (this didn't ultimately happen this month). 2. Trading calendars, will create a forward vol position. If views on that forward vol changes, you will make/lose. 3. The delta - vega hedge can work, but needless to say, you can lose when the relationship breaksdown and it does fairly often. In anyway you can lose in options, you can also earn. So you should recognize the basis risk you are adding by hedging out your nominal vega risk. That was the point of my initial post. And in volatility trading, basis risk generally means you have to trade bigger to achieve the same returns and you have to be more precise in your view and understanding of those risks.
First, a bit of general trading philosophy. A proprietary trader should avoid trading a spread where one leg of the spread is introduced for risk mitigation (there are a few exceptions to this rule, but it's a longer discussion). If you feel that an change in one of the specific metrics would be too painful, you should think of reducing the position first and think about hedging second. In case of hedging vega on an short vol position, you are changing the trade. If you are hedging delta and describing it as collecting theta, you are putting on a position based on an expectation of RV under-performing IV . Very straight forward and fairly easy to internalize. (The theta/gamma/vega are conincidental, the Greeks are for risk management rather then alpha comprehension). Once your hedge your vega with another product, you are introducing a relative value component into the trade. If you bought longer-dated option, you added a forward volatility component, relative term structure etc (forward vol is a secondary risk in a calendar unless you are more or less gamma-flat). If you buy VIX futures, you added forward vol, vol roll-down, skew and a whole bunch of other risks. So now your alpha is offset by a bunch of other risks, with a bunch of noise. Finally, if on a short gamma position you think that you can't handle the vega risk, you are doing something wrong. IMHO x2
You nailed the big problem with any long vol strategy perfectly, which is the cost of carry. I have no clue (no one does) when vol will expand and its a losing trade to just buy protection month after month. The only long term profitable long vol strategy I know of involves either covered calls or a short a put, long a call spread (same thing as a covered call just widened out). Calendars can be profitable if you manage them real early, but they are calendars. Just looking at what traded today, it looks like you could have sold the Nov 12.5 put for, what, .10, or the 12 puts for .05, there's just not that much juice to purchase a call spread there. I mean, realistically, how much protection is that really going to buy? Maybe I ratio and sell 2 of the 12.5 puts for .20 and purchase the 18/19 call spread? I mean, I don't really love that trade. Every way I look at vol there just seems to be that persistent drag you talked about. Maybe I'm missing something, but if I'm having to put up with that drag, I might as well just sell ES futures against the position (Occam's razor).
I agree with SLE's post. It's very tricky to be short vol and hedge your vega exposure. The whole point of selling vol is that you are selling the tails. Except in a few specific circumstances, I would rather trade smaller than hedge my short vol against a long vol unless that was my explicit view. Hedging short vol with futures is actually very dangerous because you have a convex risk against a linear risk and the ratios move around. It's easy to lose on the selloff (underhedged) and on the rally (overhedged). And if you are thinking about buying vix. Don't think 16 or 17. Think 27 or 37. That's what kills volatility sellers.
Thanks for the input on this. It's good to have somewhere to bounce ideas off of. I think you are spot on on saying that if a change in vega / delta would be too painful, it is time to start taking off at least part of the position.
No, he means that (a) a relief rally will hurt you on both (you lose on your short gamma and you lose on your long vega) and (b) you will find yourself losing money in calm upward market due to vols selling off without the corresponding pick-up from gamma (especially if you are already selling lower vols in the front).
I'm saying don't short deltas to hedge your vol. a rally will hurt you because you will be over short delta and a selloff will hurt you because you will be under hedged delta.