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Say you have a trading system that works best when markets are most volatile. What would be the best way to hedge against lack of volatility ? For example, 2008, 2009 was highly volatile and it has been trending down since. What's the best way to hedge and if VIX is the best one ?

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Betting against volatility is a very dangerous proposition; you never know when the world will blow-up. Best bet is to just create a different strategy that works in less-volatile times. –  chrisaycock May 24 '11 at 23:28
I am not betting against volatility! Infact, the trading system does better during volatile times. The question was how to best hedge against lack of volatility ? –  momop May 24 '11 at 23:32
Isn't simply selling volatility the easiest option here?! You make money (orhedge in other words) on time decay –  user2208 Mar 26 '12 at 10:06

4 Answers 4

If you're mostly trading equities, sell 2-3 month VIX futures, otherwise sell straddles on your non-equity assets or consider the new CME volatility futures on gold, oil, Euro.

chrisaycock isn't wrong: even if your trading system does better during volatile periods, you should be careful not to over-hedge, since losses on your short vol position(s) will probably come faster than profits from your core system.

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Hedge the risk of low-volatility by engaging in a variance-swap. Peter Carr and Lurien Wu wrote "Variance Risk Premia" on the topic.

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Write Iron Condors.

Preferably, with expiration between 21 and 45 days. Pick short strikes (call and puts) around the 30 delta for aggressive trades, and around 18 for conservative trades. Keep in mind that a 'conservative' Iron Condor blows up much worse than an aggressive one.

You always risk the spread value of your call or put spread (whichever is greater) less the credit received. The typical Iron Condor is balanced, so the call spread and put spreads are equal in risk. You only take risk on one side or the other because in our world, prices can only be at one place at a time.

This trade generates an initial credit and has positive time decay. It is short volatility and will lose 'paper' value if volatility increases or price moves towards the short strikes.

By no means would I recommend this trade, but for illustration purposes, an SPX Iron Condor this morning before the market opens is marked at $2.80 credit for strikes of 1290/1295 (put) 1345/1350 (call). This is for the Jun expiry, which is only 21 days away. The short strikes are the ones in the middle, and are sitting at about 30 deltas. Ostensibly, there is a 30% chance SPX expires higher than 1345 and a 30% chance it expires lower than 1295 by expiration. This gives you a small edge but keep in mind that Iron Condors have an expected return of zero.

Zero. Nada. Zip. You've been warned.

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What is "the 30 delta" here? Is it delta of 0.3? –  Konsta Aug 18 '12 at 10:58

Hedging against lack of volatility is per definition a spurious concept. Hedging is done exactly to AVOID volatility.

It is obvious that during volatile periods there is much more potential to make profits (for speculators) since the frequency of prices going up and down is per definition high(er). So hedging against lack of volatility is not possible. And from the above, TIME is the key here. Volatility is basically (quick) changes in prices over (short) periods of time. The only thing one can do is to stretch the time frame by trading further away contracts.

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obviously, he wants to hedge against moves in the profit of his system, not against the price movement of a stock. –  nicolas Jul 9 '11 at 11:52
some trading strategies perform better when there is high volatility. Hence hedging against low volatility can makes sense. –  RockScience Feb 1 '12 at 4:05

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