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I am reading a paper that very briefly talks about some volatility arbitrage strategies. It's so brief that I do not exactly understand how it works. It says one of the strategy is based on "short spot index volatility, long on implied volatility" on the premise that IV > realized volatility. I know how one can trade implied volatility (using a delta-hedged option portfolio), but how can I trade spot volatility?

The other arbitrage strategy is supposedly based on volatility smile: "short stock smile, long stock volatility". So unless there is a way to trade spot volatility, this seems like a contradiction.

Is there any way to trade spot volatility?

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    $\begingroup$ perhaps you could provide a link to the paper mentioned in your question $\endgroup$
    – Probilitator
    Commented Apr 7, 2014 at 7:01
  • $\begingroup$ Unfortunately that paper is confidential. It's primarily about correlation derivatives, and doesn't provide any additional information about the strategies than those I have mentioned. $\endgroup$
    – Paya
    Commented Apr 7, 2014 at 13:59

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nicolas is quite right. For completeness, AccuShares has registered new products (the VIX Up and VIX Down shares, filing here) which are designed to track spot VIX. However, this approach has not worked out particularly well in the past (consider UCR and DCR).

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I do not agree with nicolas. I think that spot volatility is represented by the front month expiry options while future volatility is represented by e.g. VIX and VSTOXX which are inherently based on a mix with options in further expiries.

Please also see the interview in the The Trader Derivatives: "...because they (Volatility futures like VIX) represent forward volatility while index or equity options are spot volatility" http://www.thetrade-derivatives-digital.com/thetradederivatives/issue_8_q3_2014#pg78

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  • $\begingroup$ There's a slight ambiguity and abuse of language here : Spot usually means buying now, forward relates to agreeing now on some price related to something determined in the future. But for vol, is you think of it as being the asset, you have cash vol provided by 1 day return (VIX etc) and you have future vol provided by say 1 month expiry option seen as being on a 1 month future not on cash. The black formula, which is sensitive to IR, makes the difference clear $\endgroup$
    – nicolas
    Commented Aug 27, 2019 at 14:10
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The first thing you have to understand that volatility is an abstraction, and there are different possible implementations of this abstraction in terms of trading.

When someone writes "short spot index volatility, long on implied volatility" they mean something like take a position in options (implied vol) and delta hedge in the underlying instrument, which creates an offsetting P/L with "spot" (underlying) volatility.

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you never directly trade spot volatility per se, you exchange it for something else :

  • if you want to exchange it for spot implied volatility, you buy a volatility swap.

  • if you want to exchange it for forward implied volatility you get options.

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