It Only Takes a Few Moments to Hedge

40 Pages Posted: 14 Dec 2017 Last revised: 1 Dec 2018

See all articles by Andrea Barletta

Andrea Barletta

Department of Economics and Business Economics - Aarhus BSS

Paolo Santucci de Magistris

Aarhus University - CREATES

David Sloth

Danske Bank - Danske Markets

Date Written: September 13, 2018

Abstract

We propose a novel non-structural method for hedging European options, relying on two model-independent results: First, under suitable regularity conditions, an option price can be disentangled into a linear combination of risk-neutral moments. Second, there exists an explicit approximate functional form linking the risk-neutral moments to the futures price of the underlying asset and the related variance swap contracts. We show that S{\&}P 500 call prices are mainly explained by two factors that are related to level and volatility of the underlying index. We empirically compare the performance of two strategies where the vega exposure is adjusted either by a direct position in a variance swap contract or, indirectly, through an at-the-money call. While both strategies ensure effective immunization in periods of market turmoil, taking direct exposure on variance swaps is not optimal during extended periods of subdued volatility.

Keywords: option Greeks, hedging, risk-neutral moments, variance-swap

JEL Classification: C38, C60, G13

Suggested Citation

Barletta, Andrea and Santucci de Magistris, Paolo and Sloth, David, It Only Takes a Few Moments to Hedge (September 13, 2018). Journal of Economic Dynamics and Control, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3086538 or http://dx.doi.org/10.2139/ssrn.3086538

Andrea Barletta (Contact Author)

Department of Economics and Business Economics - Aarhus BSS ( email )

Fuglesangs Allé
Aarhus V, 8210
Denmark
+45 8716 5372 (Phone)

HOME PAGE: http://pure.au.dk/portal/en/abarletta@econ.au.dk

Paolo Santucci de Magistris

Aarhus University - CREATES ( email )

Department of Economics and Business Economics
Fuglesangs Allè 4
Aarhus V, 8210
Denmark

David Sloth

Danske Bank - Danske Markets ( email )

Holmens Kanal 2-12
DK-1092 Copenhagen K
Denmark

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