The first session kicking off the 2014 CBOE Risk Management Conference Europe was led by Paul Stephens from CBOE and Colin Bennett Head of Quantitative and Derivative Strategy at Banco Santander Central Hispano. Bennett is also the author of Trading Volatility which may be found at www.trading-volatility.com.
This session was a great primer for the information that is going to be delivered throughout the rest of the conference. The three topics covered were volatility risk premium, hedging and long volatility strategies, and VIX and volatility trading.
Volatility Risk Premium
The discussion of volatility risk premium actually began by showing the performance of the CBOE BuyWrite Index (BXM) on an absolute and risk adjusted basis. It was then noted that BXM has worked well over time due to the volatility risk premium or that realized volatility has been consistently overpriced by implied volatility.
Hedging and Long Volatility Strategies
The most common hedging strategy involves buying puts which defines risk and also allows a position to be held so an investor may still participate in upside price moves. A strategy that is often discussed is a portfolio tail hedge which may be implemented through buying VIX calls or buying out of the money SPX puts. Many investors have started implementing tail hedge strategies that combine long SPX puts and long VIX Calls. It was also noted that the best protection against a big equity market move to the downside will depend on the nature of the market drop. Sometimes going to cash works best, while at other times hedging with puts through either a long option position or spread will be the most effective strategy.
VIX and Volatility Trading
To start the final part of this session, the VIX calculation and settlement process were touched on. VIX is actually a measure of a portfolio of out of the money SPX options which tend to have different levels of volatility. The result is that VIX is a constant volatility exposure over several strike prices. VIX settlement is based on opening trades on a wide variety of option contracts which means settlement is based on the pricing of a strip of options and not at the money implied volatility. Additionally, VIX option pricing that should be based off the forward VIX price was covered.