Trading Volume as an Underlying Risk and Its Hedging Challenges
Summary
The document asks whether investors can take positions whose payoff depends directly on trading volume rather than on asset prices or price derivatives. One response argues that volume is not typically an input to standard derivative valuation and suggests indirect exposure through owning exchange shares, whose business may benefit from greater trading activity. That exposure would also reflect other drivers of the shares’ price.
A second response highlights practical design problems for a hypothetical volume-linked contract: market makers may be unable to hedge its risk, and contracts tied to a single security’s volume could be vulnerable to manipulation near a payoff threshold. Broad market volume may be harder to manipulate, though the answer does not establish that manipulation is impossible. The discussion is exploratory and does not present a pricing model or survey existing products. Its categorical claim that volume cannot support a valuation model is asserted rather than demonstrated, so the material is best read as a discussion of hedging and contract-design concerns.
Key ideas
- The discussion considers direct exposure to trading volume and indirect exposure through exchange shares.
- Exchange share prices can reflect trading activity along with many other factors.
- A volume-linked contract may expose its market maker to risks that are difficult to hedge.
- Contracts based on narrow volume measures may be susceptible to manipulation.
- The document raises design concerns but does not provide a valuation method or comprehensive product survey.
Tags
Full text
# Are there financial instruments that make a bet on traded volume instead of price or its derivatives? # Are there financial instruments that make a bet on traded volume instead of price or its derivatives? For most financial instruments we can go long or short and make a bet on the price. In the case of options we can bet on derivatives of price and other factors (e.g., interest rates). Is there an instrument or a strategy that can benefit from changes in trading volume, besides buying and selling equity in an exchange? ## Answer by Lliane (score 4, accepted) https://quant.stackexchange.com/a/2227 No, there isn't, there is no valuation model where volume plays a role, thus you can't make money from volume. But you can buy NYSE-Euronext stocks, they will benefit from increased volume in the owned exchanges, that is if you hedge everything else that could make NYSE-Euronext stocks move. ## Answer by kfmfe04 (score 4) https://quant.stackexchange.com/a/2230 I can think of at least two problems with such a security, should one be devised: - It is probably unhedgeable. That means if you go long this contract, the market-maker is short unless he can hedge that risk away somehow (or sell it to someone else). - Unless it is on something large like the volume traded on the NYSE in one day, such a contract may be prone to manipulation. Suppose I buy such a contract on APPL and it gets close to hitting the strike on the contract. I could send a large block order to push it over the top. It's harder to do against the entire market, but with derivatives, it may be possible. But if, somehow, should such a contract ever be devised, brokers, who are naturally long volume (due to the positive correlation with commissions), may be interested in selling time premium to hedges some of their risk.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.