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International Volatility Arbitrage

Last Updated on 10 February, 2024 by Rejaul Karim

Venturing into the intricate realm of global financial markets, the research paper titled “International Volatility Arbitrage” by Adriano Tosi unfolds a captivating exploration into options on exchange-traded products (ETPs) and indexes.

This study, with an international focus, illuminates a fascinating narrative of consistent mispricing within the cross-section of international option returns. This anomaly comes to light through meticulous sorting based on ex-ante volatility returns. However, the plot thickens as the research reveals an additional layer—selling international ETP options while strategically acquiring corresponding index options unveils a positive risk premium.

These compelling revelations, economically significant on a global scale, beckon alpha seekers to broaden their perspectives beyond domestic options. The institutional nuances embedded in seemingly similar international derivatives add complexity to the enticing landscape of systematic volatility arbitrage.

Abstract Of Paper

Are options on exchange-traded products (ETPs) and indexes consistently priced internationally? The cross-section of international option returns exhibits a mispricing by sorting on ex-ante volatility returns. In addition, selling international ETP options and buying their corresponding index options commands a positive risk premium. Both empirical findings are economically large and pervasive internationally, whereas they are comparably small domestically. While volatility hedge funds are exposed towards domestic option products, they neglect the possibility of engaging in foreign volatility arbitrage. These findings entail that alpha seekers may expand their horizon towards international derivatives which at first glance are similar, but institutionally are not.

Original paper – Download PDF

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Author

Adriano Tosi
Wellington Management

Conclusion

In conclusion, this study sheds light on the intriguing realm of international volatility arbitrage, exploring the consistent mispricing observed in options on exchange-traded products (ETPs) and indexes across borders. The cross-section of international option returns reveals a discernible mispricing pattern, particularly evident when sorting on ex-ante volatility returns.

Moreover, a compelling positive risk premium emerges from selling international ETP options while concurrently purchasing their corresponding index options, presenting an economically significant and globally pervasive phenomenon.

Notably, this mispricing phenomenon is more pronounced on the international stage compared to the domestic landscape. The implications suggest that those seeking alpha may find promising opportunities in expanding their focus to international derivatives, highlighting the nuanced institutional distinctions that make foreign volatility arbitrage a distinctive avenue for potential returns.

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FAQ

– What is the main focus of the study on international volatility arbitrage, and what key mispricing pattern does it uncover in options on exchange-traded products (ETPs) and indexes across borders?

The study primarily focuses on international volatility arbitrage, specifically exploring options trading involving exchange-traded products (ETPs) and indexes on a global scale. The key mispricing pattern unveiled in the study lies within the cross-section of international option returns. Through a meticulous sorting process based on ex-ante volatility returns, the research identifies a consistent mispricing phenomenon in the international options market.

– How does the study reveal a positive risk premium in the context of international volatility arbitrage, and what trading strategy is associated with this premium?

The study uncovers a positive risk premium in the realm of international volatility arbitrage. This premium is revealed through the trading strategy of selling international ETP options while strategically acquiring corresponding index options. The positive risk premium identified is not only economically significant but also pervasive on a global scale. The research suggests that this strategy, associated with a positive risk premium, can be a compelling avenue for investors seeking alpha in the international derivatives market.

– What are the implications of the study’s findings regarding the mispricing phenomenon in international volatility arbitrage, especially in comparison between the international and domestic stages?

The study highlights that the mispricing phenomenon in international volatility arbitrage is more pronounced on the international stage compared to the domestic landscape. The findings underscore nuanced institutional distinctions in seemingly similar international derivatives, adding complexity to the landscape of systematic volatility arbitrage. The study suggests that investors seeking alpha may find promising opportunities by expanding their focus to international derivatives, considering the distinctive dynamics that make foreign volatility arbitrage a potentially rewarding and unique strategy.

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