sample 1, when current implied interest rate will exceed future rate, appropriate strategy to hedge volatility risk is hedging dynamically, instead of using options why???
Here’s the rule of thumb: If Expected Volatility > Implied Volatility, use options to hedge If Expected Volatility < Implied Volatility, use dynamic hedge (Futures) The reason is that option values rise with increased volatility. PJStyles
even though the following is not always right, for me this works: if expected volatility is higher than current, current volatility is cheap, so buy options (I know, this is not correct) otherwise, dynamic hedge with futures
If volatility ends up being higher than implied, option values will increase more. Hence, if you expect the volatility to be higher than current/implied, go with options. It all comes back to how volatility results in increased value of options because they will be more likely to be “in the money” as opposed to when there’s no volatility.
Thanks for putting this in the context of volatility and option value. I was afraid I was going to have to do straight memorization for this topic, but now I don’t have to…