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

Author

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  • Hong Yu Xin Pan
  • Jun Song

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.

Suggested Citation

  • Hong Yu Xin Pan & Jun Song, 2017. "Volatility cones and volatility arbitrage strategies – empirical study based on SSE ETF option," China Finance Review International, Emerald Group Publishing Limited, vol. 7(2), pages 203-227, May.
    • Handle: RePEc:eme:cfripp:cfri-05-2016-0041
    DOI: 10.1108/CFRI-05-2016-0041
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    Citations

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    Cited by:

    1. Gong, Xu & Lin, Boqiang, 2018. "Structural changes and out-of-sample prediction of realized range-based variance in the stock market," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 494(C), pages 27-39.
    2. Zargar, Faisal Nazir & Kumar, Dilip, 2020. "Heterogeneous market hypothesis approach for modeling unbiased extreme value volatility estimator in presence of leverage effect: An individual stock level study with economic significance analysis," The Quarterly Review of Economics and Finance, Elsevier, vol. 77(C), pages 271-285.
    3. Gong, Xu & Lin, Boqiang, 2019. "Modeling stock market volatility using new HAR-type models," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 516(C), pages 194-211.
    4. Yu, Xiao-Jian & Wang, Zi-Ling & Xiao, Wei-Lin, 2020. "Is the nonlinear hedge of options more effective?—Evidence from the SSE 50 ETF options in China," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).

    More about this item

    Keywords

    ETF options; Transaction costs; Option hedging; Volatility arbitrage; Volatility cones; G11; G13;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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