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volatility trading

Hello everyone,

Rivas moves on to a specialist hedge fund strategy that focuses exclusively on volatility trading. Adding this fund to an investor’s portfolio strives to hedge long equity positions. The Taurus Fund typically implements the following three trades in its strategy:

  • Trade 1: Sell exchange-traded and over-the-counter equity call options on a market index. Selection of the options depends on the volatility smile and skew.

  • Trade 2: Sell VIX futures to capture the volatility premium and roll-down payoff.

  • Trade 3: Purchase a receiver volatility swap with an at-inception fair value of zero

    Which of the trades undertaken by the Taurus Fund is most likely to accomplish the objective that Rivas sets as the reason for considering the strategy

    Solution

    Trade 3.Equities and volatility are negatively correlated. In order to hedge the equity exposure in the portfolio, a long volatility position is necessary.

    Can someone please explain why a long volatility position can hedge the equity exposure?

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I found as an explanation as in: being long the volatility in this case means “as volatility increases, the value of your position increases”. Being long smth means you expect a rise… in this case, a rise in volatility, but would that not have a negative effect on the equity, since they are negatively correlated? How can long volatility be a hedge here?

Thanks a lot

what does “long smth” mean? Missing some words?

I meant, for instance, being long an asset.

Here, same principle: long volatility means you expect long volatility.

could someone please explain this example? Thanks

C. You need to be more specific. The Q’s. Is ambiguous. As a receiver volatility swap, you will be paying when Volatility comes down ( below the reference point) and will be winning when the volatility increases. This is no brainier.

What is not clear is what is the reference asset ?

The same equity ? Any options written on the equity ? Any interest rate derivative ? There needs to be specific mention of the underlying. The hedging technique is correct though.

back against the wall. no retreat no surrender.

To hedge long equity exposure, you need to buy puts. This means you are long volatility.