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Statistical Arbitrage in Leveraged ETF Option Volatility Surfaces

Article arXiv papers · Author: Sergey Nasekin et al.
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Summary

The paper tests whether moneyness scaling makes implied volatility smiles for leveraged and unleveraged ETF options statistically alike. It builds bootstrap uniform confidence bands to compare the smiles after scaling and finds that differences remain, suggesting the transformation does not fully reconcile them.

For a trading application, the authors develop a statistical arbitrage decision method using a dynamic semiparametric factor model. It compares observed leveraged ETF implied volatility surfaces with model estimates to produce trade recommendations. The paper reports positive returns with high probability and also examines out-of-sample forecasting and latent volatility-surface dynamics. These findings indicate potential opportunities in the studied market, but the summary provides no performance figures or details about transaction costs, implementation, or the scope of the data. It also adapts the scaling method to a Heston stochastic volatility setting for tractability.

Key ideas

  • Bootstrap uniform confidence bands indicate that moneyness scaling does not eliminate statistical differences between leveraged and unleveraged ETF option smiles.
  • A dynamic semiparametric factor model compares observed and modeled implied volatility surfaces to generate trade recommendations.
  • The authors report that the strategy produced positive returns with high probability.
  • The analysis includes out-of-sample forecasting and a study of implied volatility surface dynamics.
  • A Heston stochastic volatility formulation is incorporated into the scaling method.

Tags

OptionsVolatilityArbitrageStatisticsDerivatives pricing
Full text
# Model-driven statistical arbitrage on LETF option markets


# Model-driven statistical arbitrage on LETF option markets









In this paper, we study the statistical properties of the moneyness scaling transformation by Leung and Sircar (2015). This transformation adjusts the moneyness coordinate of the implied volatility smile in an attempt to remove the discrepancy between the IV smiles for levered and unlevered ETF options. We construct bootstrap uniform confidence bands which indicate that the implied volatility smiles are statistically different after moneyness scaling has been performed. An empirical application shows that there are trading opportunities possible on the LETF market. A statistical arbitrage type strategy based on a dynamic semiparametric factor model is presented. This strategy presents a statistical decision algorithm which generates trade recommendations based on comparison of model and observed LETF implied volatility surface. It is shown to generate positive returns with a high probability. Extensive econometric analysis of LETF implied volatility process is performed including out-of-sample forecasting based on a semiparametric factor model and uniform confidence bands' study. It provides new insights into the latent dynamics of the implied volatility surface. We also incorporate Heston stochastic volatility into the moneyness scaling method for better tractability of the model.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.