Volatility Arbitrage
A strategy that takes long/short positions across implied vs realized volatility, dispersion (index vol vs single-name vol), and term-structure of vol — typically dynamically delta-hedged.
Details
- aliases: Vol Arb, Dispersion Trading
- category: relative-value
- investment thesis: The variance risk premium (long-run wedge between implied and realized) and dispersion patterns are systematically mispriced by hedging flows and structured-product issuance.
- edge source: Option pricing models, gamma/vega risk management, and understanding of structured-product flows.
- typical holding period: Days to months
- drawdown profile: Short-vol overlays produce smooth carry punctuated by sharp drawdowns (e.g., Volmageddon, 2018).
- correlation to equities: -0.2
- correlation to bonds: 0.0
- liquidity profile: monthly
- instruments used: equity index options, single-stock options, VIX futures, variance swaps
- asset classes: derivatives, equities
- primary risks: vol-of-vol, tail events, model risk, liquidity in single-name options
- key metrics: delta-hedged P&L, vega exposure, implied vs realized, VRP capture
- related terms: variance-risk-premium, dispersion-trade, implied-volatility, vix, delta-hedging
- related strategies: convertible-arbitrage, statistical-arbitrage
- academic foundations: Black-Scholes (1973), Carr-Wu (2009) — Variance Risk Premium