In the Volatility of Volatility presentation at the Risk Management Conference John-Mark Piampiano from Pine River Capital and Edward Tom from Credit Suisse teamed up for a great presentation. Tom started out noting that volatility of volatility has become a more mainstream discussion due to CBOE publishing VVIX and even the CFA Journal publishing work on volatility of volatility.
Tom notes that there are various methods of gaining exposure to the volatility in the equity markets including SPX options, SPY options, variance swaps, volatility swaps, VIX futures, VIX options and options on VIX related exchange traded products. The market participants in this space include trading for or hedging against a potential black swan event, taking a directional position based on a volatility outlook, specifically trading the volatility or volatility or even trying to find volatility arbitrage situations between different markets.
Market participants that care about volatility include equity portfolio managers, commentators, and option traders. However, these market participants look at volatility a bit differently. Portfolio managers are most concerned with the standard deviation of returns or realized volatility. Commentators tend for focus on price changes in VIX or the realized volatility of VIX while option traders are looking at the implied volatility of VIX options or VVIX.
Tom also talked about the components of the risk premium associated with VIX. He broke this down into realized volatility of VIX, the demand for hedging (skew), and the volatility accorded to tail risk (kurtosis). With respect to the premium in VVIX Tom also said there are three components to the risk. The VVIX risk component are the realized volatility of VIX futures, the hedging demand for VIX calls, and the change of volatility regimes back and forth between different average levels.
Piampiano started out saying that VIX is very liquid and more so than some European index futures markets. When comparing VIX futures and options to the underlying equity market the VIX products offer very few arbitrage opportunities. This can be taken as those products being consistently fairly valued. It is interesting that he considers VIX options and SPX options to both be based on the same (S&P 500 complex) and they often consider them interchangeably depending on their outlook. He did note in recent years that SPX options have been a bit more expensive than VIX options on a carry neutral basis. VIX futures offer a good and cheap method of scalping volatility gamma.
SPX put versus VIX call trading if they are both the same how do you decided between the two? Piampiano noted that they look at things in an arbitrage context and consider VIX futures relative to VIX to determine if VIX futures are expensive. Then the thought is if SPX options are cheap relative to VIX futures then buy the SPX options, if SPX options are expensive relative to VIX futures then buy VIX options. Also the target of a maturity comes into play as well. Tom added that simplicity and size liquidity also come into play when considering the trade. Another thought around choosing VIX versus SPX is that in a low VIX environment there is a floor value of VIX (based on history) that can be taken into account.