Quant Mashup - Relative Value Arbitrage Is a 4% Down Day a Black Swan? [Relative Value Arbitrage]wn Day a Black Swan? On February 5, the SP500 experienced a drop of 4% in a day. We ask ourselves the question: is a one-day 4% drop a common occurrence? The table below shows the number of 4% (or more) down days since 1970. 4% down 4% down and bullish From 1970 40 5 On average, a 4% down day(...) Mean Reverting and Trending Properties of SPX and VIX [Relative Value Arbitrage]In the previous post, we looked at some statistical properties of the empirical distributions of spot SPX and VIX. In this post, we are going to investigate the mean reverting and trending properties of these indices. To do so, we are going to calculate their Hurst exponents. There exist a variety(...) Statistical Distributions of the Volatility Index [Relative Value Arbitrage]VIX related products (ETNs, futures and options) are becoming popular financial instruments, for both hedging and speculation, these days. The volatility index VIX was developed in the early 90’s. In its early days, it led the derivative markets. Today the dynamics has changed. Now there is strong(...) Are Short Out-of-the-Money Put Options Risky? Part 2: Dynamic Case [Relative Value Arbitrage]This post is the continuation of the previous one on the riskiness of OTM vs. ATM short put options and the effect of leverage on the risk measures. In this installment we’re going to perform similar studies with the only exception that from inception until maturity the short options are(...) Are Short Out-of-the-Money Put Options Risky-Leverage Increases Risks [Relative Value Arbitrage]Traders often debate whether short out-of-the-money (OTM) or at-the-money (ATM) puts are riskier. The argument for OTM put options being riskier is that their Speeds (or dGamma/dspot) are higher than the ATMs’ ones, thus the Gamma, which is negative, can increase (in absolute value) substantially(...) Using a Market Timing Rule to Size an Option Position, A Static Case [Relative Value Arbitrage]In the previous installment, we discussed the use of a popular asset allocation/market timing rule (10M SMA rule hereafter) to size a short option position. The strategy did not work well as it was the case in traditional asset allocation. We thought that the poor performance was due to the fact(...) Using a Market Timing Rule to Size an Option Position [Relative Value Arbitrage]Position sizing and portfolio allocation have not received much attention in the options trading community. In this post we are going to apply a simple position sizing rule and see how it performs within the context of volatility trading. An option position can be sized by using, for example, a(...) Is There a Less Expensive Hedge Than a Protective Put? [Relative Value Arbitrage]The spot VIX index finished last Friday at 11.28, a relatively low number, while the SKEW index was making a new high. The SKEW index is a good proxy for the cost of insurance and right now it appears to be expensive. A high reading of SKEW means investors are buying out of the money puts for(...) A Volatility Skew based Trading Strategy [Relative Value Arbitrage]In previous blog posts, we explored the possibility of using various volatility indices in designing market timing systems for trading VIX-related ETFs. The system logic relies mostly on the persistent risk premia in the options market. Recall that there are 3 major types of risk premium:(...) Relationship Between the VIX and SP500 Revisited [Relative Value Arbitrage]A recent post on Bloomberg website entitled Rising VIX Paints Doubt on S&P 500 Rally pointed out an interesting observation: While the S&P 500 Index rose to an all-time high for a second day, the advance was accompanied by a gain in an options-derived gauge of trader stress that usually(...) Volatility Trading Strategies, A Comparison of VRP and RY Strategies [Relative Value Arbitrage]In previous posts, we presented 2 volatility trading strategies: one strategy is based on the volatility risk premium (VRP) and the other on the volatility term structure, or roll yield (RY). In this post we present a detailed comparison of these 2 strategies and analyze their recent performance.(...)