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Volatility cones and volatility arbitrage strategies – empirical study based on SSE ETF option

Hong Yu Xin Pan (Fudan University, Shanghai, China)
Jun Song (Fudan University, Shanghai, China)

China Finance Review International

ISSN: 2044-1398

Article publication date: 15 May 2017

Abstract

Purpose

Using volatility cones as the estimate of actual volatility instead of GARCH models, the purpose of this paper is to explore whether volatility arbitrage strategy can provide positive profits and how the transaction costs existed in the real market affect the effectiveness of volatility arbitrage strategy.

Design/methodology/approach

A number of hedging approaches proposed to improve the hedging results and final returns of Black-Scholes model are analyzed and compared.

Findings

The general finding is that volatility arbitrage strategy can provide satisfactory returns based on the samples in Chinese market. Regarding transaction costs, the variable bandwidth delta and delta tolerance approach showed better results. Besides, choosing futures together with ETFs as hedging underlying can increase the VaR for better risk management.

Practical implications

This paper offers a new method for volatility arbitrage in Chinese financial market.

Originality/value

This paper researches the profitability of the volatility arbitrage strategy on ETF 50 options using volatility cones method for the first time. This method has advantage over the point-wise estimation such as GARCH model and stochastic volatility model.

Keywords

Acknowledgements

National Science Fund of China (71371055).

Citation

Pan, H.Y.X. and Song, J. (2017), "Volatility cones and volatility arbitrage strategies – empirical study based on SSE ETF option", China Finance Review International, Vol. 7 No. 2, pp. 203-227. https://doi.org/10.1108/CFRI-05-2016-0041

Publisher

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Emerald Publishing Limited

Copyright © 2017, Emerald Publishing Limited