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Volatility Selling Strategies

Volatility selling strategies have performed better than one would expect through the 2008 tsunami.  These strategies relate well to my previous article “Picking up Nickels in front of a Steam Roller“.  The first point that they make is that up until 2008, the markets since 1990 have been relatively calm and there has been a consistent option premium that has rewarded option sellers via a positive gap between option implied volatility and actual realized volatility.

Mostly positive until 2008

Mostly positive until 2008

The second part of the piece focused on the relative performance of different volatility strategies.  They explored a 95-105 strangle (sell 5% out of the money put and 5% out of the money call), ATM Straddle (sell a put and a call at the money), Delta Hedged Straddle (sell ATM Straddle and delta hedge the straddle daily), and a recently popular Variance swap which basically pays the difference between realized and implied volatility based upon the swaps terms.

Variance Swaps - Ouch!

Variance Swaps - Ouch!

The first thing that stands out is that a delta hedged strategy has the highest information ratio, just think of this as the return per unit risk (standard deviation).  The second most notable issues is the face that the variance swap wiped out over 5 years of gains due to 2008.   The main reason for this was the incorrect pricing of the convexity premium in the variance swap, which is a fancy way of saying that the distribution of volatility was much more fat tailed than expected.  On the opposite side I was very surprised by the outcome from a Naked ATM Straddle.  Its rebound from the hits it took during the end of 2008 was very fast due to the mean reversion type returns of the S&P 500.  In the past I had been leaning towards a 95-105 strategy, but this certainly adds some validity to the ATM strategy for those who are willing to take the added volatility of returns.

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10 Responses

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  1. Randy Woods says

    Can you provide a link to the source document from Barclays? Or tell me the title and I’ll try to find it on Bloomberg.

  2. SurlyTrader says

    Randy –

    I am replying via e-mail.


  3. Stephen Almond says

    Sorry I’m late to the party. You have a great blog.

    Do you have more details of these strategies?
    On the face of it a simple straddle writing system seems like a winner,
    Surely, it’s too good to be true?


  4. Ben says


    interesting article!

    What expiration was used when testing the strangle/straddle? Always the front month?
    And how many contracts were traded? Always a one contract strangle/straddle?

    Thanks an regards

  5. joseph kaufman says

    May I ask where is the best information on how to best delta hedge the straddles?

    Thanks so much,


  6. theta says

    I don’t know if you still read comments here, given it’s an old post, but I just saw it for the first time (linked from a newer post of yours). So, my question is, how would selling a delta-flat strangle compare? That is, selling for example the 25 delta put and the 25 delta call, whatever the strikes are at any given time. This probably means something like 93-94% puts and 103-104% calls or thereabouts.

  7. Sal says

    I tried to replicate the ATM straddle, and OTM strangle back-test using both weekly and monthly options. My data is from Bloomberg going back to 1994. I had to make a few assumptions about the weeklies and the OTMs because the Bloomberg data only has ATM implied on monthlies (it has additionals from 2005 onward). But I am not getting such rosy results. The above chart implies a 11% annualized return, but calibrated to market data, I am showing a 3-4% annualized with an IR of .4. Also, when I compared the implied to VIX, I am showing a premium of around 3%, and if comparing the implied to 1 month forward historical, the premium drops to 1%. Could you also send me the source document so I can find out if I am missing something here? Thanks.

Continuing the Discussion

  1. Collapsing Volatility – SurlyTrader linked to this post on September 29, 2009

    […] and I have offered evidence of how much option writing strategies outperform over time in “Volatility Selling Strategies“.  In general, the spread between implied volatility and realized volatility has […]

  2. Option Selling on the Nikkei | SurlyTrader linked to this post on July 12, 2010

    […] I am always looking for confirmation that option selling strategies perform well over time and I have focused most of my time on US markets.  In general, I have found that selling strangles or straddles on the S&P 500 has been very profitable through market cycles.  Please refer to my previous article for that proof. […]

  3. Volatility Arbitrage | SurlyTrader linked to this post on March 28, 2012

    […] There is a broad  misconception that options have a “cost”.  This perception is derived from the fact that put buyers are “buying downside protection” while call buyers are purchasing upside rights without downside risk.  The thought is that if you are buying protection, then it costs much like car or house insurance costs.  In many cases, this can be true because there is a risk premium built into option prices.  That risk premium is simply the difference between what implied volatilities are priced into options  and what realized volatility turns out to be.  The difference between the implied volatility and the realized volatility of the option is its cost.  The problem with saying it is a *cost* is the fact that realized volatility can most definitely end up being higher than the implied volatility of the option.  You can read more about this in Volatility Selling Strategies. […]

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