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Being Right Is Not Enough: Buying Options to Bet on Higher Realized Volatility

Roni Israelov and Harsha Tummala
The Journal of Alternative Investments Fall 2020, jai.2020.1.109; DOI: https://doi.org/10.3905/jai.2020.1.109
Roni Israelov
is the chief investment officer and president of NDVR, Inc., in Boston, MA
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Harsha Tummala
is a managing director at AQR Capital Management, LLC, in Grerenwich. CT
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Abstract

Speculators who wish to bet on higher future volatility often purchase options to “go long volatility.” Should investors who buy options expect to profit when realized volatility increases? If so, under what conditions? To answer these questions, we conducted an analysis of the relationship between long volatility performance (buying options) and contemporaneous changes in volatility. We found that buying one-month S&P 500 options was only consistently profitable in the highest decile of changes in one-month volatility. Buying options consistently lost money in the lowest seven deciles of changes in volatility. We then studied the trade entry and exit timing required to retain the profits from long option positions during significant volatility increases. We found similar results between the S&P 500 options market and global equity option markets.

TOPIC: Options

Key Findings

  • • We explore the relationship between buying options and contemporaneous changes in volatility, and find that buying one-month, delta-hedged S&P 500 options is only consistently profitable in the highest decile of changes in one-month volatility.

  • • We also find that monetizing gains from long option positions during volatility spikes requires very precise trade entry and exit timing.

  • • We find similar results between the S&P 500 option market and global equity option markets.

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The Journal of Alternative Investments: 23 (3)
The Journal of Alternative Investments
Vol. 23, Issue 3
Winter 2021
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Being Right Is Not Enough: Buying Options to Bet on Higher Realized Volatility
Roni Israelov, Harsha Tummala
The Journal of Alternative Investments Aug 2020, jai.2020.1.109; DOI: 10.3905/jai.2020.1.109

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Being Right Is Not Enough: Buying Options to Bet on Higher Realized Volatility
Roni Israelov, Harsha Tummala
The Journal of Alternative Investments Aug 2020, jai.2020.1.109; DOI: 10.3905/jai.2020.1.109
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  • Article
    • Abstract
    • DATA DESCRIPTION
    • CHANGES IN VOLATILITY AND THE VOLATILITY RISK PREMIUM
    • BETTING ON INCREASING VOLATILITY
    • (MIS)TIMING THE ENTRY AND EXIT
    • INTERNATIONAL EVIDENCE
    • LONG VOLATILITY AS AN EQUITY HEDGE
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • ADDITIONAL READING
    • ENDNOTES
    • REFERENCES
  • Info & Metrics
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  • PDF (Subscribers Only)

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