# Hypothetic derivative that absorbs underlying volatility

Market participants are usually assumed to be risk-averse and striving to improve the Sharpe ratios of their portfolios. Thus, if we have an asset A, which is expected to return between \$900 and \$1100, and an asset B, which is expected to return something between \$500 - \$1500, then on the market should price A higher. For example, the A may cost \$995, while B \$975.

This reasoning predicts a potential existence of particular option-like securities that would absorb those assets' expected volatility. Such security, being sold, should probably cost around a difference between the average and assets market price, so the owner of asset A could buy it for \$5, while the other for, say, \$25. The security seller would receive the premium + all potential gains and losses from the underlying on a particular date.

What puzzles me is that I seemingly cannot construct something like this from securities accessible to a DIY investor like me, a combination of stocks, bonds, options, futures. Everything I could come up with causes the "seller" in the example above to pay the premium. For example, longing a call and shorting a put on the same strike price will be a net negative.

So, assuming a random walk with normal distribution, the questions are:

• Does anything like this exist in the finance world?
• Is it going to have at least a positive value for the holder? If no, why?
• Can you reproduce it with a set of options?
• I have trouble understanding, but would it be similar to a variance swap? – Dimitri Vulis Feb 9 at 2:13
• > For example, longing a call and shorting a put on the same strike price will be a net negative... Can you explain this part? – Sergei Rodionov Feb 9 at 7:12
• @SergeiRodionov I meant a "synthetic long stock" here – Nikolay Rys Feb 9 at 8:58
• @NikolayRys. Yes, but what is "net negative"? Is it the cost of time decay compared of holding the underlying? – Sergei Rodionov Feb 9 at 10:58
• @SergeiRodionov Sorry, I wanted to say that the line on the payoff diagram of synthetic long stocks is shifted down. – Nikolay Rys Feb 9 at 11:21