Spreads outperform outright options after volatility spikes
The guest argued that when hedging reactively after a market shock has already occurred, investors should utilize wide option spreads rather than purchasing outright options to mitigate paying inflated premiums.
The argument
Once a market move has begun and volatility has gone bid, outright options become structurally overpriced over the cycle. Utilizing spreads allows investors to participate in further upside while mitigating the high cost of entry.
The thesis, stress-tested
✓ What validates it
- ✓Implied volatility of outright options remains elevated or declines (vol crush) after a market move
▸ Risks discussed
- ▸Capped upside compared to outright options if an extreme move occurs
Hear it yourself
"There is the vol risk premium. We also know, as you just referenced, that there is a fat tail, oftentimes a left fat tail, especially in financial assets like the S and P. And so you can win, win, win, win, and and lose a lot. There is the skewness of negative returns. How should people think about the big picture of hedging set against the VRP and also set against the experience that the five standard deviation event in markets happens much more frequently than a model can really capture, a distributional model? Okay. There's a lot in there."
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