Market Measures

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Historical vs Theoretical Risk

Market Measures

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The basic short volatility, directionally neutral trade we employ is the strangle.

We have many varieties that we use however: 10, 16, 20, 30 and 40 deltas strangles.

What strategy would be optimal if we wanted to get short the most volatility (take on the most theoretical risk) with the least amount of realized historical risk?

Study
  • SPY, 2005-present
  • 45 DTE
  • 10, 16, 20, 30, 40 delta strangles
  • Observed:
    • Historical volatility of P/L when managed at 21 days (realized historical risk)
    • Current vega (theoretical risk)

We find that the theoretical/actual risk ratio is the same for all delta strangles, implying that risk is priced efficiently across all deltas that we trade.

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