Tryon is long several equity positions based on event-driven ideas that, over the next few quarters, are expected to have double-digit returns. He is concerned, however, that the equity market may decline as a result of lower corporate earnings. He believes investors are complacent as reflected in the historically low level of the volatility index (VIX). He wants to establish volatility exposure as a tail hedge for his holdings and notices the VIX futures curve is in contango. Tryon evaluates three potential trades to establish his hedge:
· Trade 1: Go long back-end month futures contracts on the VIX Index, with a gross notional equal to the portfolio market value.
· Trade 2: Sell a rolling series of out-of-the-money put options on VIX futures.
· Trade 3: Go long a variance swap, with vega notional equal to the potential equity portfolio loss.
Question
Which trade is Tryon most likely to implement to establish his equity market hedge?
1. Trade 1
2. Trade 2
C. Trade 3
Solution
C is correct. Variance swaps have a valuable convexity feature—as realized volatility increases (decreases), the positive (negative) swap payoffs increase (decrease)—which makes them particularly attractive for hedging long equity portfolios. Because the volatility curve is in contango—that is, higher volatility is priced into the curve—Trade 1 is likely to experience roll-down losses as the futures price converges or is “pulled down” to the spot price. Trade 2 would benefit from a decrease rather than an increase in volatility; an alternative trade in the options space would be to buy call options to hedge the portfolio.
为什么trade 2 是benefit from decrease呢？
put option会benefit from decrease 但是我们现在是sell put option 所以不应该是benefit from increase 吗？因为我们是卖家啊
另外，trade 3 为什么是 vega notional 而不是 variance notional?为什么不是 portfolio market value 而是eq portfolio loss?
