Gaining the Alpha Advantage in Volatility Trading (Presentation Slides)

Abstract

We present some empirical evidence for short volatility strategies and for the cyclical pattern of their P&L. The cyclical pattern of the short volatility strategies produces an alpha in good times but collapses to the beta in bad times. We introduce a factor model with risk-aversion to explain the risk-premium of short volatility strategies as a compensation to bear losses in bad market regimes. We then consider an econometric model for statistical inference of market regimes and for optimal position sizing. Finally, we illustrate model applications for generating alpha from volatility strategies.

Keywords: Volatility trading, risk-premia, cyclicality risk, diversification

JEL Classification: G10, G11, G12