Volatility as an Asset Class


A nice overview of the cyclical nature of volatility trading by Jonathan Kinlay entitled, “The Case for Volatility as an Asset Class”. For options traders, the idea of volatility as an asset class is taken for granted. For most others, it’s likely they’ve never given these strategies much of a thought. That’s unfortunate given the excellent diversification (i.e. uncorrelated returns) provided by most volatility strategies.

A few highlights from the article:

So an investment strategy than [sic] seeks to exploit volatility trends is relying upon one of the most consistent features of any asset process we know of.

A long volatility fund might lose money month after month for an entire year, and with it investors and AUM, before seeing the kind of payoff that made such investment torture worthwhile.

The previous observation, while well known, is further confirmed by the recent news that, “A ‘Black Swan’ Fund Makes $1 Billion”.

Conversely, stories about managers of short volatility funds showing superb performance, only to blow up spectacularly when volatility eventually explodes, are legion in this field.

The moral is simple: one cannot afford to be either all-long, or all-short volatility. The fund must run a long/short book, buying cheap Gamma and selling expensive Theta wherever possible, and changing the net volatility exposure of the portfolio dynamically, to suit current market conditions.