Let's say I have found a method that fairly accurately predicts whether implied volatility will be above or below future realized volatility (as well as the magnitude of that spread). Normally I would want to trade variance swaps, but what if I don't have access to them? What is the best way to trade options to capture vega? Strangles and butterflies? What risks are there (theta?) that I have to be aware of? Would this be cheaper or more expensive than just replicated the cash-flow the variance swap (portfolio of European puts & calls)? Any benefits you can see from trying to trade the vega directly versus a swap? Thanks
Straddles, with a procedure to adjust the delta and/or roll the strikes... Big problem is transaction costs.
Yes, and the fact that reasonably priced adjustments cause your position to enlarge, so that you have to trade in a pretty small size to be sure to be able to adjust when necessary. This will reduce returns, but should not stop you.
1) A variance swap is not a volatility swap, which is what it sounds like what you want. 2) A volatility swap is more "complicated" to trade/model than a variance swap. 3) Knowing IV vs RV is no guarantee of profit (non-linear) in the presence of (delta) hedging in the underlying paths. 4) Your question about which strategy to use is a trick question. It depends on what part of volatility you want to trade, curvature, absolute level,... If you aware of all these things, and that you have to have pretty good commissions to be able to do this (almost certainly need a broker with no cancel fees imo), and you have either software that helps you enter spreads (I am fortunate to be a programmer and have extensive tools that I developed to help me execute my option strategies), or you are real good at legging in by hand, you can give it a try but imo keep your positions very small for at least one expiration cycle, as you are opening a hornets nest of things that can go wrong.
Actually, I meant a variance swap. The goal is to trade the spread between RV and IV Fortunately, I am a programmer as well, so that is no issue. I will see if I can get anything good out of this. Thanks for the info guys.