Short-Volatility Trades as Hedges for Low-Volatility Strategies
Summary
The document considers how a strategy that performs best in volatile markets might respond to quieter conditions. Suggested approaches include selling medium-dated VIX futures for equity exposure, selling straddles or using volatility futures for other markets, entering a variance swap, and writing iron condors. These are presented as possible ways to benefit from low volatility, rather than as hedges with guaranteed offsetting behavior.
The iron-condor discussion describes receiving an initial credit and benefiting from time decay, while losing value if volatility rises or the underlying moves toward a short strike. It also explains that losses are limited by the spread width less the credit, but highlights the risk of a large adverse move. One response cautions that short-volatility losses can arrive faster than gains from the core strategy; another questions whether low volatility can be hedged at all. The answers offer conflicting views and illustrative guidance, not comparative performance evidence or a tailored risk analysis.
Key ideas
- Short volatility positions may benefit when markets remain quiet, but can lose sharply when volatility rises.
- Responses suggest VIX futures, straddles, volatility futures, variance swaps, and iron condors.
- An iron condor collects premium and has positive time decay, with risk concentrated in adverse price moves or volatility increases.
- The document cautions against over-hedging and notes that views differ on whether low volatility is meaningfully hedgeable.
Tags
Full text
# How to hedge against lack of volatility # How to hedge against lack of volatility Say you have a trading system that works best when markets are most volatile. What would be the best way to hedge against lack of volatility ? For example, 2008, 2009 was highly volatile and it has been trending down since. What's the best way to hedge and if VIX is the best one ? ## Answer by Jared (score 7) https://quant.stackexchange.com/a/1235 If you're mostly trading equities, sell 2-3 month VIX futures, otherwise sell straddles on your non-equity assets or consider the new CME volatility futures on gold, oil, Euro. chrisaycock isn't wrong: even if your trading system does better during volatile periods, you should be careful not to over-hedge, since losses on your short vol position(s) will probably come faster than profits from your core system. ## Answer by Ram Ahluwalia (score 3) https://quant.stackexchange.com/a/3294 Hedge the risk of low-volatility by engaging in a variance-swap. Peter Carr and Lurien Wu wrote "Variance Risk Premia" on the topic. ## Answer by Milktrader (score 1) https://quant.stackexchange.com/a/1237 Write Iron Condors. Preferably, with expiration between 21 and 45 days. Pick short strikes (call and puts) around the 30 delta for aggressive trades, and around 18 for conservative trades. Keep in mind that a 'conservative' Iron Condor blows up much worse than an aggressive one. You always risk the spread value of your call or put spread (whichever is greater) less the credit received. The typical Iron Condor is balanced, so the call spread and put spreads are equal in risk. You only take risk on one side or the other because in our world, prices can only be at one place at a time. This trade generates an initial credit and has positive time decay. It is short volatility and will lose 'paper' value if volatility increases or price moves towards the short strikes. By no means would I recommend this trade, but for illustration purposes, an SPX Iron Condor this morning before the market opens is marked at $2.80 credit for strikes of 1290/1295 (put) 1345/1350 (call). This is for the Jun expiry, which is only 21 days away. The short strikes are the ones in the middle, and are sitting at about 30 deltas. Ostensibly, there is a 30% chance SPX expires higher than 1345 and a 30% chance it expires lower than 1295 by expiration. This gives you a small edge but keep in mind that Iron Condors have an expected return of zero. Zero. Nada. Zip. You've been warned. ## Answer by Val (score -1) https://quant.stackexchange.com/a/1415 Hedging against lack of volatility is per definition a spurious concept. Hedging is done exactly to AVOID volatility. It is obvious that during volatile periods there is much more potential to make profits (for speculators) since the frequency of prices going up and down is per definition high(er). So hedging against lack of volatility is not possible. And from the above, TIME is the key here. Volatility is basically (quick) changes in prices over (short) periods of time. The only thing one can do is to stretch the time frame by trading further away contracts.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.