Using VaR Forecasts to Structure a Call Spread Trade

Summary

The document considers whether forecasts of Value at Risk from volatility models such as GARCH can support a profitable trade. Its proposed example is to buy a call spread with a strike at the forecast VaR level, provided the spread is priced below the stated confidence threshold. The intended payoff is triggered when losses breach the VaR threshold, linking the trade to the forecast's tail-risk estimate.

The answer claims this could be profitable on average, but explicitly characterizes the idea as highly optimistic. It offers no derivation, pricing assumptions, backtest, or evidence that option prices systematically undervalue the breach probability. The proposal therefore serves as a speculative illustration of connecting risk forecasts to options, not as a validated strategy. In particular, the document does not clarify contract selection, spread width, costs, or how to account for the difference between a VaR forecast and the full distribution of tail outcomes.

Key ideas

• A VaR forecast can be used as an input to a proposed options trade.
• The suggested structure is a call spread struck at the forecast VaR level.
• The proposal assumes the spread is priced below the relevant confidence threshold.
• The answer provides no empirical validation and describes the profitability claim as optimistic.

Tags

# Profitability on Value at Risk forecasting


# Profitability on Value at Risk forecasting












I'm conducting a research related to Value at Risk forecasting using volatility models like GARCH and others. My predictions are turning out quite well with some models. Is there a way to capitalize on these predictions? For example, a trading strategy that utilizes VaR prediction as input, so my profitability depends on how accurate my VaR prediction is? Perhaps with options? Thanks!

## Answer by Arshdeep (score 0, accepted)

https://quant.stackexchange.com/a/79242

Buy a call spread at strike equal to VaR if it's valued at less than your confidence (say 99%). This will get a payout everytime there is a VaR breach, and on average should be profitable. This is though very optimistic.

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