How Volatility Exposure Appears in Carry, Equity, Bond, and FX Positions
Summary
The document discusses how positions can behave like volatility exposures even when they are not options. Currency carry is described as generally short volatility: carry returns tend to weaken when currency volatility rises and improve when it falls. The suggested empirical check is to compare carry profits with currency volatility or a broad volatility proxy, while historical stress episodes offer anecdotal context.
Other examples include diversified equity indices, which are characterized as tending to have negative exposure to volatility, and the differing volatility effects that can accompany calls and puts. Government bond futures may act as long equity volatility when duration and risky assets move in opposite directions, while a foreign investor’s dollar exposure can provide a similar hedge in some periods. These are conditional relationships, not universal rules: the document cautions that single stocks may differ from broad indices and that the relevant correlations depend on market regimes and investor currency.
Key ideas
- Currency carry trades are commonly treated as short volatility because turmoil can coincide with losses.
- Carry returns can be compared with currency volatility or a broad volatility proxy to examine this relationship.
- Diversified equity indices are described as tending to have negative exposure to volatility, though individual stocks may differ.
- Bond futures and foreign currency positions can provide volatility exposure that depends on correlations and market regime.
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# Short Volatility # Short Volatility Being net short options is an obvious case of being short volatility. But what other investments are "functionally" short volatility? Is long equities long or short volatility? Is short Apple long or short volatility? Does a yield curve trade have a volatility component? If you are in the carry trade, short one currency to be long another currency to capture interest rate differentials, do you have a defined volatility position? ## Answer by Alex C (score 3) https://quant.stackexchange.com/a/17768 The currency carry trade is generally said to be short volatility. The reason is that when [currency] volatility rises, the carry trade suffers, and when volatility falls, the carry trade does well. You can do a regression of carry trade profits vs volatility [either currency volatility, or even just the VIX as a proxy for all volatility]; or just anecdotally it seems that the big losses are in months when there is a lot of turmoil, like in late 2007 if I remember well. ## Answer by Richi Wa (score 1) https://quant.stackexchange.com/a/17772 Some thoughts about this very interesting question: - A long position in a diversified stock index (I would not bet that this is true for all single stocks) quite surely results in a short position in volatility. The correlation here is something like $-0.7$ (as books tell, this is of course just an indication. - Therefore I have observed the phenomenon that a call is less of a long position in volatility than a put. If the stock price rises the call appreciates in value but as vol tends to decrease the move is dampened. For puts a decrease in price tends to be accompanied by rising vola and the price rises even more. - In times where duration is negatively correlated to risky assets (especially stocks) - usually a risk-on/risk-off period it tends to be positively correlated with (stock) volatility. Thus something like Bund or Treasury futures long correlates with stock vola long (with a beta very different from 1). - Carry trades work if "everything" (yield curve shapes, differentials, ...) stay the same. In times of high volatility (as Alex C writes) such trades can suffer. - For a Euro investor a short in USD is like long stocks resp. short volatility. In times of (stock) volatility the USD tends to rise against the EUR. Then being long USD helps.
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