Harvesting Volatility Risk Premium with Equity Index Options

Kari Vatanen ()
Additional contact information
Kari Vatanen: Elo Mutual Pension Insurance Company

Chapter Chapter 29 in Derivatives Applications in Asset Management, 2025, pp 425-432 from Springer

Abstract: Abstract The volatility risk premium (VRP) refers to the consistent difference between the implied volatility in option prices and the realized volatility of the underlying asset arising from market participants’ demand for protection against uncertainty. This premium, driven by institutional hedging activity and behavioral biases, offers a systematic opportunity for generating absolute returns. This chapter explains how asset managers can harvest the VRP through strategies that sell options to monetize this discrepancy while managing associated risks. More specifically, it provides an in-depth analysis of a one-month ATM straddle strategy on the S&P 500 Index, where both call and put options are sold to collect premiums, paired with daily delta hedging using futures to minimize directional risk. This strategy is highlighted for its ability to capture the VRP systematically while mitigating the potential for large losses during sharp market moves. The discussion further explores alternative approaches, such as safer structures like iron condors, which add additional out-of-the-money hedges to limit downside risks. The case emphasizes the importance of disciplined risk management in executing VRP-based strategies, addressing challenges such as volatility spikes and market dislocations. Refinements, including more frequent hedging and diversification across strike prices and expiration dates, are suggested to improve performance and reduce exposure to sudden market shocks.

Keywords: Volatility risk premium; Options selling; Delta hedging; Iron condors; Risk management (search for similar items in EconPapers)
Date: 2025
References: Add references at CitEc
Citations:

There are no downloads for this item, see the EconPapers FAQ for hints about obtaining it.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:spr:sprchp:978-3-031-86354-7_29

Ordering information: This item can be ordered from
http://www.springer.com/9783031863547

DOI: 10.1007/978-3-031-86354-7_29

Access Statistics for this chapter

More chapters in Springer Books from Springer
Bibliographic data for series maintained by Sonal Shukla () and Springer Nature Abstracting and Indexing ().