Volatility Timing Using ETF Options: Evidence from Hedge Funds

We find that hedge funds’ positions in exchange-traded fund (ETF) options contain volatility information about underlying ETF returns. Greater hedge fund option demand predicts higher abnormal variance of ETF returns over the following quarter and on days of macroeconomic news releases. The predictive power is stronger for options on non-equity ETFs, like fixed income and currency ETFs. A tracking portfolio of straddles based on funds’ straddle positions earns quarterly abnormal returns of 7.35%. Net of fees, funds using ETF straddles deliver lower risk and higher benchmark-adjusted returns than nonusers. We conclude that ETF options are an important venue for market volatility timing strategies.

Keywords: Hedge funds, Exchange-traded funds, Options, Volatility timing

JEL Classification: G11, G12, G23

Suggested Citation: Suggested Citation

Aragon, George O. and Chen, Shuaiyu and Shi, Zhen, Volatility Timing Using ETF Options: Evidence from Hedge Funds (October 13, 2022). Available at SSRN: https://ssrn.com/abstract=4246146 or http://dx.doi.org/10.2139/ssrn.4246146