Valuing OTC Options on Volatility Control Indexes

Summary

The note explains that options on volatility control indexes exist, even though they may not appear as exchange-listed contracts. It says these options are generally embedded in structured notes and are mainly traded over the counter. This provides a reason a search for listed exchange products may not find them.

For valuation, the answer says such options generally lack analytical pricing formulas and suggests Monte Carlo simulation. It also describes a practical trader convention: valuing them at the index's controlled volatility level under a constant-volatility assumption, characterized as conservative. The document gives no model details, calibration procedure, or evidence comparing this convention with simulation, so it does not establish when that approximation is suitable.

Key ideas

• Options on volatility control indexes exist and are often embedded in structured notes.
• These products are described as mainly over-the-counter rather than exchange-listed.
• Monte Carlo simulation is suggested because analytical valuation formulas are usually unavailable.
• A constant-volatility assumption at the controlled level is described as a practical conservative valuation convention.
• The note does not specify how to calibrate or validate that convention.

Tags

# Options on Volatility Control Index


# Options on Volatility Control Index












I have two question.

Does an option on volatility control index exist? If I google it, it seems like there is such an option, but I can't find the option on any of exchanges. So this is my first question.

Is it possible that the option can be OTC? From my knowledge, options are all listed on the exchange.

Thanks in advance!

## Answer by Gordon (score 1)

https://quant.stackexchange.com/a/18484

There does exist some volatility control indexes (e.g., see page 37 of the S & P index methodology, which can be downloaded from http://ca.spindices.com/documents/methodologies/methodology-index-math.pdf?force_download=true), and also options on them, which are usually embedded in certain structured notes (e.g., google "Risk Aligned Deposit Notes").

However, these are mainly OTC based. For valuation, they usually do not have analytical formulas, and Monte Carlo simulation should be used. However, in practice, the trader likes to value them at the controlled volatility levels, that is, assuming constant volatility, in a so called conservativeness sense.

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