Volatility Trading
Volatility trading refers to the trading strategies that are based on the expectation of future volatility of an underlying asset. There are several types of volatility trading strategies in derivatives, including:
- Delta-neutral straddle: This strategy involves buying both a call and put option with the same strike price and expiration date on the same underlying asset. The strategy is designed to profit from a significant move in either direction, while limiting the potential loss in case the market remains stagnant.
- Vega-neutral trading: Vega refers to the sensitivity of the option price to changes in the implied volatility of the underlying asset. Vega-neutral trading involves buying and selling options in such a way that the overall vega exposure is zero. This strategy aims to profit from changes in implied volatility, regardless of the direction of the underlying asset.
- Volatility skew trading: Volatility skew refers to the difference in implied volatility between options of different strike prices on the same underlying asset. In this strategy, traders take advantage of the difference in implied volatility to buy low and sell high.
- Volatility arbitrage: This strategy involves taking advantage of pricing discrepancies between options of the same underlying asset but with different strike prices or expiration dates. The goal is to profit from the difference in implied volatility between the options.
- Volatility index (VIX) trading: The VIX is a measure of the expected volatility of the S&P 500 index. Trading on the VIX involves buying and selling futures and options contracts based on the VIX level. The strategy is designed to profit from changes in the VIX level.
These are some of the common volatility trading strategies in derivatives. Traders may use a combination of these strategies or create their own customized strategies based on their risk appetite and market outlook.