Evaluating Long-Volatility Strategies with Options and Variance Swaps

# Are there any books/articles on how to use options to be long volatility (implied or realized)?


# Are there any books/articles on how to use options to be long volatility (implied or realized)?












Given the market turmoil of late I have become fixated with this idea of using options to be long volatility (realised and implied). However, I dont know where to start, what to read, who to follow etc to actually understand how this is done in practice.

For instance, what strategies do traders use to execute a long vol strategy (presumably it is not as simple as buying a put or buying a call)?

And how does one go about delta hedging a portfolio of options which are long vol?

Does anyone have any ideas?

Appreciate the help on this

## Answer by nbbo2 (score 4, accepted)

https://quant.stackexchange.com/a/52894

The simplest long vol strategy is to be long an ATM straddle and delta hedge it, the problem is that when it is no longer ATM the exposure to vol weakens. You could then sell that straddle and enter another ATM one.

Another solution is the vol swap or variance swap mentioned by Stephane below. It gives constant exposure no matter what the level of S&P. But be careful: var swap gives you exposure to squared vol so huge P&L when vol spikes (many vol traders and institutions were recently taken to the cleaners if short). Also they have some other drawbacks that Stephane mentioned.

## Answer by Stéphane (score 4)

https://quant.stackexchange.com/a/52886

What not to do

What you are asking us, without knowing, is related to how to price a variance swap. Well, under a general diffusion process, variance swaps can be priced by forming a suitably weighted portfolio of options over a continuum of strike prices with the entire portfolio maturing on a given date. The intuition is that your exposure to volatility changes when the the spot price of the underlying changes for one option: in financial parlance, your vega is a function of the spot price. But for a pure volatility exposure, you'd like to get rid of that dependance.

The unfortunate thing is that if you move toward a model that admits conditional nonnormality in returns (in continuous time, a jump-diffusion model would do just that), you're demonstrably incapable of pricing variance swaps: you don't have a strategy that allows you to build pure exposure to volatility because quadratic variation is going to be polluted by higher moments (see Martin (2017) for details). I mention this obvious problem in case someone

What to do

On the other hand, there is something you can do which is valid, even under the general context of jump-diffusions. Variance swaps focus on the observed quadratic variation in the growth rate of log prices, so they're always polluted by higher order term. Martin introduced the idea of simple variance swaps (their payoff depend on squared price changes, weighted by squared futures prices) to build a new index. As it happens, just like the VIX is built by discretizing the integrals used in the pricing of variance swaps, his index is also built from a portfolio of European options on the S\&P500...

All you have to do, if you want to "go long volatility" is to look up Martin (2017), find the integral defining his index (the SVIX) and discretize it. You have a portfolio of options, just not weighed the same way as in the VIX. To determine how many options you need in practice, pick a few jump-diffusion models, run simulations and see how many options you need to get precise results. That method absolutely will give you exactly what you need to know to be long vega in as general a context as can be -- you know, outside stable processes where what you're asking wouldn't make any sense.

## Answer by user34971 (score 2)

https://quant.stackexchange.com/a/52892

I do not mean to discourage you, but it sounds like you're a wee bit late for this round of volatility games, for two reasons:

- You are still trying to figure out how to implement a long vol strategy.

- The market has already priced the risk in, i.e. buying volatility is already expensive.

However, never too late to learn and prepare for a next time. My suggestion would be first learn what delta hedging a single option really is. Explore delta hedging under Black-Scholes, then what happens if the world does not follow Black-Scholes but you do, and so forth.

Once you understand the basics of Black-Scholes and you are specifically looking at vol trading, then Euan Sinclair's book is a good place to start:

Euan Sinclair, Volatility Trading