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
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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