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- Rolling Short Variance
Rolling Short Variance
One of the most successful carry-trade strategies has been systematically selling short-dated index variance.
This strategy:
- takes advantage of the volatility risk premium.
- has returns on average positive, but with large negative tail.
- LT rolling strategy will allow to diversify away these occasional large losses over time.
Comparison of rolling short vol strategies using: variance swaps / delta-hedged straddles / naked straddles
1. Variance Swaps
- deliver the most consistent alpha across different volatility environments
- most effectively capture the premium of IV to RV.
2. Naked Straddles
- avoid the negatively convex payoff which can hurt short VS in times of high vol
- extremely path-dependent
- can suffer in time of low-vol trending market
3. Delta-hedged Straddles
- better work than naked straddles to capture premium of IV to RV
- can suffer in trending markets --> away from strikes, gamma exposure reduced.
With returns from short volatility trades somewhat un-correlated with the underlying, these types of strategy work well as overlay strategies aimed at boosting alpha and diversifying returns.