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The Profitability of Volatility Spread Trading on ASX Equity Options
Author(s) -
Do Binh Huu,
Foster Anthony,
Gray Philip
Publication year - 2016
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.21729
Subject(s) - profitability index , volatility (finance) , economics , equity (law) , transaction cost , exploit , financial economics , econometrics , monetary economics , microeconomics , finance , computer science , computer security , political science , law
Abstract Goyal and Saretto (2009) conjecture that deviations of option implied volatility from long‐run historical levels—the volatility spread—provide a signal of option mispricing. This paper re‐examines the profitability of trading the volatility spread, with a particular focus on assessing the authenticity of returns. While, at face value, portfolios of option straddles designed to exploit this mispricing appear highly profitable, our findings cast doubt over whether these profits can be genuinely attained in real‐world settings. Drawing on the tick history of bid–ask quotes, our analysis suggests that transaction costs erode much of the profitability. Further, we demonstrate that ignoring the existence of initial margins dramatically overstates estimated returns to short option positions. Ultimately, the profitability of volatility spread trading appears to hinge on the ability of traders to achieve effective spreads well inside the quoted spreads and to intelligently time their trades. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 36:107–126, 2016