The profitability of volatility spread trading on ASX equity options

Binh Huu Do, Anthony Foster, Philip Gray

Research output: Contribution to journalArticleResearchpeer-review

1 Citation (Scopus)

Abstract

Goyal and Saretto (2009) conjecture that deviations of option implied volatility from long-run historical levels-the volatility spread-provide a signal of option mispricing. This paper re-examines the profitability of trading the volatility spread, with a particular focus on assessing the authenticity of returns. While, at face value, portfolios of option straddles designed to exploit this mispricing appear highly profitable, our findings cast doubt over whether these profits can be genuinely attained in real-world settings. Drawing on the tick history of bid-ask quotes, our analysis suggests that transaction costs erode much of the profitability. Further, we demonstrate that ignoring the existence of initial margins dramatically overstates estimated returns to short option positions. Ultimately, the profitability of volatility spread trading appears to hinge on the ability of traders to achieve effective spreads well inside the quoted spreads and to intelligently time their trades.
Original languageEnglish
Pages (from-to)107-126
Number of pages20
JournalJournal of Futures Markets
Volume36
Issue number2
DOIs
Publication statusPublished - 1 Feb 2016

Cite this

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abstract = "Goyal and Saretto (2009) conjecture that deviations of option implied volatility from long-run historical levels-the volatility spread-provide a signal of option mispricing. This paper re-examines the profitability of trading the volatility spread, with a particular focus on assessing the authenticity of returns. While, at face value, portfolios of option straddles designed to exploit this mispricing appear highly profitable, our findings cast doubt over whether these profits can be genuinely attained in real-world settings. Drawing on the tick history of bid-ask quotes, our analysis suggests that transaction costs erode much of the profitability. Further, we demonstrate that ignoring the existence of initial margins dramatically overstates estimated returns to short option positions. Ultimately, the profitability of volatility spread trading appears to hinge on the ability of traders to achieve effective spreads well inside the quoted spreads and to intelligently time their trades.",
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The profitability of volatility spread trading on ASX equity options. / Do, Binh Huu; Foster, Anthony; Gray, Philip.

In: Journal of Futures Markets, Vol. 36, No. 2, 01.02.2016, p. 107-126.

Research output: Contribution to journalArticleResearchpeer-review

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