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Archive for February, 2012

Pricing Methods and Hedging Strategies for Volatility Derivatives

28 Feb

Article by: H. Windcliff, P.A. Forsythy, K.R. Vetzal
Published by: The Journal of Derivatives
Date: 4 May 2003

“In this paper we investigate the behaviour and hedging of discretely observed volatility derivatives. We begin by comparing the effects of variations in the contract design, such as the differences between specifying log returns or actual returns, taking into consideration the impact of possible jumps in the underlying asset. We then focus on the difficulties associated with hedging these products. Naive delta-hedging strategies are ineffective for hedging volatility derivatives since they require very frequent rebalancing and have limited ability to protect the writer against possible jumps in the underlying asset. We investigate the performance of a hedging strategy for volatility swaps that establishes small, fixed positions in straddles and out-of-the-money strangles at each volatility observation.”

Full article (PDF): Link

 
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Posted in Hedging, Investing ideas

 

Volatility Risk Premiums Embedded in Individual Equity Options: Some New Insights

05 Feb

Article by: Gurdip Bakshi and Nikunj Kapadia
Published by: The Journal of Derivatives
Date: Fall 2003

“The research indicates that index option prices incorporate a negative volatility risk premium, thus providing a possible explanation of why Black-Scholes implied volatilities of index options on average exceed realized volatilities. This examination of the empirical implication of a market volatility risk premium on 25 individual equity options provides some new insights.

“While the Black-Scholes implied volatilities from individual equity options are also greater on average than historical return volatilities, the difference between them is much smaller than for the market index. Like index options, individual equity option prices embed a negative market volatility risk premium, although much smaller than for the index option — and idiosyncratic volatility does not appear to be priced.

“These empirical results provide a potential explanation of why buyers of individual equity options leave less money on the table than buyers of index options.”

Full article (PDF): Link

 
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Posted in Implied volatility, Realized volatility