Department of Economics and Business Economics

It Only Takes a Few Moments to Hedge

Research output: Working paperResearch

Standard

It Only Takes a Few Moments to Hedge. / Barletta, Andrea; Santucci de Magistris, Paolo; Pedersen, David Sloth.

Rochester, NY : Social Science Research Network (SSRN), 2017.

Research output: Working paperResearch

Harvard

Barletta, A, Santucci de Magistris, P & Pedersen, DS 2017 'It Only Takes a Few Moments to Hedge' Social Science Research Network (SSRN), Rochester, NY.

APA

Barletta, A., Santucci de Magistris, P., & Pedersen, D. S. (2017). It Only Takes a Few Moments to Hedge. Rochester, NY: Social Science Research Network (SSRN).

CBE

Barletta A, Santucci de Magistris P, Pedersen DS. 2017. It Only Takes a Few Moments to Hedge. Rochester, NY: Social Science Research Network (SSRN).

MLA

Barletta, Andrea, Paolo Santucci de Magistris and David Sloth Pedersen It Only Takes a Few Moments to Hedge. Rochester, NY: Social Science Research Network (SSRN). 2017., 25 p.

Vancouver

Barletta A, Santucci de Magistris P, Pedersen DS. It Only Takes a Few Moments to Hedge. Rochester, NY: Social Science Research Network (SSRN). 2017 Dec 12.

Author

Barletta, Andrea ; Santucci de Magistris, Paolo ; Pedersen, David Sloth. / It Only Takes a Few Moments to Hedge. Rochester, NY : Social Science Research Network (SSRN), 2017.

Bibtex

@techreport{00f03f00de17447c8887edcce72bd7e2,
title = "It Only Takes a Few Moments to Hedge",
abstract = "Traders hedge the risks carried by options and other securities using the so-called Greeks, with the delta and the vega being the most prominent. In this paper, we propose a novel non-structural method for hedging European options, relying on two model-independent results: First, under suitable regularity conditions on the risk-neutral density, an option price can be disentangled into a linear combination of risk-neutral moments. Second, there exists an explicit functional form linking the risk-neutral moments to the price of the underlying asset and the related variance swap contracts. We show that, historically, S&P 500 call prices are mainly explained by two factors that are related to level and volatility of the underlying index. Based on this, we devise and empirically compare the hedging performance of two strategies where the vega exposure is adjusted either by taking a direct position in variance swap contracts or, indirectly, through an ATM call option. While both strategies ensure effective immunization in periods of market turmoil, taking direct exposure on volatility might not be optimal during extended periods of subdued market volatility. We argue that this result is related to the phenomenon known as the {"}low VIX puzzle{"}.",
keywords = "option Greeks, hedging, risk-neutral moments, low VIX puzzle",
author = "Andrea Barletta and {Santucci de Magistris}, Paolo and Pedersen, {David Sloth}",
year = "2017",
month = "12",
day = "12",
language = "English",
publisher = "Social Science Research Network (SSRN)",
type = "WorkingPaper",
institution = "Social Science Research Network (SSRN)",

}

RIS

TY - UNPB

T1 - It Only Takes a Few Moments to Hedge

AU - Barletta, Andrea

AU - Santucci de Magistris, Paolo

AU - Pedersen, David Sloth

PY - 2017/12/12

Y1 - 2017/12/12

N2 - Traders hedge the risks carried by options and other securities using the so-called Greeks, with the delta and the vega being the most prominent. In this paper, we propose a novel non-structural method for hedging European options, relying on two model-independent results: First, under suitable regularity conditions on the risk-neutral density, an option price can be disentangled into a linear combination of risk-neutral moments. Second, there exists an explicit functional form linking the risk-neutral moments to the price of the underlying asset and the related variance swap contracts. We show that, historically, S&P 500 call prices are mainly explained by two factors that are related to level and volatility of the underlying index. Based on this, we devise and empirically compare the hedging performance of two strategies where the vega exposure is adjusted either by taking a direct position in variance swap contracts or, indirectly, through an ATM call option. While both strategies ensure effective immunization in periods of market turmoil, taking direct exposure on volatility might not be optimal during extended periods of subdued market volatility. We argue that this result is related to the phenomenon known as the "low VIX puzzle".

AB - Traders hedge the risks carried by options and other securities using the so-called Greeks, with the delta and the vega being the most prominent. In this paper, we propose a novel non-structural method for hedging European options, relying on two model-independent results: First, under suitable regularity conditions on the risk-neutral density, an option price can be disentangled into a linear combination of risk-neutral moments. Second, there exists an explicit functional form linking the risk-neutral moments to the price of the underlying asset and the related variance swap contracts. We show that, historically, S&P 500 call prices are mainly explained by two factors that are related to level and volatility of the underlying index. Based on this, we devise and empirically compare the hedging performance of two strategies where the vega exposure is adjusted either by taking a direct position in variance swap contracts or, indirectly, through an ATM call option. While both strategies ensure effective immunization in periods of market turmoil, taking direct exposure on volatility might not be optimal during extended periods of subdued market volatility. We argue that this result is related to the phenomenon known as the "low VIX puzzle".

KW - option Greeks

KW - hedging

KW - risk-neutral moments

KW - low VIX puzzle

M3 - Working paper

BT - It Only Takes a Few Moments to Hedge

PB - Social Science Research Network (SSRN)

CY - Rochester, NY

ER -