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. 

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