How to trade delta-neutral straddles if iv can be forecasted reasonably well?

This may be a dumb question. Say I have a model that can forecast the delta neutral straddle iv of one asset reasonably well, out of sample, with a horizon of 10~20 trading days. But the price of the underlying, or the price of the straddle can't be predicted. How should I trade it? I assume one would need to constant delta-hedge the position remain delta neutral.

For delta-neutral straddle (or just ATM option for approximation), assume simple BS formula, short duration, it can be reduced to (https://quant.stackexchange.com/que...l-approximations-to-the-black-scholes-formula)
call = put = StockPrice * 0.4 * volatility * Sqrt( Time )
So essentially I can forecast the ratio (iv) between the option price and underlying price. I have read some papers like this: https://www.researchgate.net/public...y_prices_an_application_to_options_on_the_DAX. They just constantly close/open new straddles depending on if tomorrow's iv forecast is higher/lower, which doesn't seem very practical for many assets due to slippage. Also this way it is not purely trading iv, still gets impacted by underlying's movement. Any suggestions? thank you.

 

• Long or short straddles?
• I assume delta-neutral is a clue - but option greeks are all gobbledygook to me.

 

if you re long vol, PnL will roughly average vega *( future realized vol - Implied you paid for), vice versa for shorts. delta hedging frequency will determine your expected PnL vol

 

Hello Phoenix,

I believe what you are looking for are vol swaps. But afaik they are not all that accessible to retail traders. Probably OTC if you have access to them somewhere. I could be wrong though..

Hth
-gariki

 

Thanks for the reply. From the PnL formula, does it mean that even if one can forecast IV perfectly, the PnL is still not deterministic because realized vol/vega is not known? Maybe I am missing something here. Is there a trade setup that can profit purely based on IV?

Here is one plot I am working on. The 2M delta-neutral straddle price on /CL, vs future close and IV. The straddle price is following the 0.4 x underlying x IV x sqrt(DTE) reasonably well. Say for period between July 08 to Jan 09, IV of the straddle is increasing (doubled), but the underlying is dropping fast, as a result the straddle price dropped a lot. So if I forecast perfectly that IV would rise in the 2nd half of 08, and long the delta-neutral straddle, I would be losing money on the straddle, and also incur losses on the delta hedge (since I would be increasing long futures in a declining market to delta hedge)? I feel like something is wrong in this analysis but don't know where...

 

Thanks. That's what I am afraid of. I read about vol/variance swaps, seems like they are more of a "pure play" on vol, whereas the vanilla options for retails have path dependence on the underlying. I remember either CBOE or CME introduced vol/variance swaps for retails years ago, but remains dead with zero volume over the years?

 

vega is known, just do a web search for greek calculation formulas. It feels like you dont really understand how options are valued yet, it's best to master the fundamentals first.