Let's say I am predicting the realised volatility of a stock index. I am buying or selling straddles based on whether the predicted vol is higher or lower than the implied ATM volatility for the maturity. I am delta hedging along the way and potentially rolling the strikes if my options are moving too far away from ATM due to spot moves. If my prediction is good, my "Gamma Theta PnL" from this strategy should be positive. However, there is still Vega PnL and I do not want exposure to this. Is there a way to hedge out Vega PnL, so that my PnL is mostly driven by Gamma and Theta? What do people usually do in the market? I was thinking of using a vol swap or variance swap, but could imagine that this would be very expensive in terms of transaction fees.


1 Answer 1


Use calendar spreads. If implieds are high vs your prediction, sell short dated straddles, buy longer dated straddles, vega neutral. If implieds are lower vs your prediction, buy short dated straddles, sell longer dated straddles, vega neutral. Your short dated straddles will have more gamma (and theta) than your longer dated straddle positions and therefore you will have net gamma (and theta) exposure but be vega neutral. You will be approximately vega neutral by buying and selling the same number of straddles in the calendar spread.

  • $\begingroup$ thanks. I am looking at S&P 500 index options. I tried calendar spreads, but it still doesn't look too good when I using my signal on 1M vs 2M calendars. It seems that the calendar spread has exposure to steepening or flattening of the vol term structure and roll down effects and in my backtest these effects can take away large parts of my Gamma Theta profits. $\endgroup$
    – Volwiz
    Sep 19, 2020 at 21:06
  • $\begingroup$ As my former boss used to say to me "the market is not there to make your job easy" ;)) $\endgroup$
    – nbbo2
    Sep 20, 2020 at 16:48
  • $\begingroup$ I mean how long are you holding the trade for. If you are exposed to rolldown effects, can't you just go long the option and just deal with the change in pnl via vega. If realized vol greater than IV, theoretically, you should make money holding it to expo. $\endgroup$
    – confused
    Sep 21, 2020 at 11:50

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