Volatility Arbitrage

What is Volatility Arbitrage?

One of the most important aspects in the trading world is understanding key concepts and strategies. Volatility Arbitrage is one such concept. So, what is Volatility Arbitrage? Before we understand this, let's look at what 'volatility' and 'arbitrage' mean separately.

Understanding Volatility

'Volatility' refers to the rate at which the price of an asset, such as an index or a security, moves for a set amount of return. Volatility is often measured by the standard deviation of the returns over a specific period. In trading, high volatility means good profit or loss opportunity.

Understanding Arbitrage

'Arbitrage' on the other hand, refers to exploiting the price difference between two or more markets for a risk-free profit. Traders buy a cheaper version of an asset and sell a more expensive version simultaneously.

Now, Volatility Arbitrage Explained

In simple terms, Volatility Arbitrage (Vol Arb) is a trading strategy that attempts to profit from the difference between implied and realized volatility in an asset's return. It is a type of statistical arbitrage.

Traders use Volatility Arbitrage to take a position on the spread between the forecasted future price-volatility of a stock, and the implied volatility of options contracts.

Key Features of Volatility Arbitrage

Three key features make Volatility Arbitrage appealing. First, it is a market-neutral strategy. This means it does not depend on the general direction in which the market moves. Second, it is risk-averse as it focuses on exploiting price differences rather than predicting market trends. And third, it potentially yields high returns due to the inherent volatility in the market.

In Conclusion

Volatility Arbitrage is a complex but rewarding trading strategy. It takes time to master but once it is understood, there are significant profits to be made. Remember, this strategy relies heavily on precise calculations and a deep understanding of market trends and behaviours.