Wednesday, March 14, 2007

CBOE Introduces New Benchmark Index - CBOE S&P 500 VARB-X Strategy Benchmark Provides Performance Measure for Volatility Arbitrage Trading

I normally don't like to quote press releases, but I found the CBOE’s announcement of a new benchmark index for selling volatility to be particularly interesting:

“The Chicago Board Options Exchange (CBOE) today announced that it will begin publishing a new benchmark index, the CBOE S&P 500 VARB-X Strategy Benchmark (VTY) on Friday, March 16, 2007. The new index tracks the performance of a hypothetical volatility arbitrage trading strategy designed to capitalize on the historical difference between S&P 500 Index (SPX) option implied volatility and the realized, or historical, volatility of the S&P 500 Index.

…The CBOE S&P 500 VARB-X ("Volatility ARBitrage") Strategy Benchmark tracks the performance of a simulated trading strategy that systematically sells Three-Month Volatility Futures* and holds the short position through expiration. The value of the benchmark is calculated from the profit or loss on the short futures position, plus the interest income derived from the available capital used to finance the portfolio.”

The CBOE has a strategy paper that spells out the details of this benchmark index and the underlying strategy. You can find more information at the CBOE VARB-X site. A graphic of the back-tested performance of this strategy over the past 32 months is below:


Bill Luby said...

Just to state what may be obvious to some: while the VARB equity curve makes for a nice picture, I'd love to see what it would have looked like going back a few more years. Selling volatility for the past 8 months has been like stealing.

If you look at the chart on the bottom of my first post here, you can see that the CBOT has chosen as a 'relevant' time frame a period that fits the strategy perfectly: a steady decline in the VIX from 45 to 10.

Another way to think about the equity curve and Sharpe ratio is that the 19% return and 2.37 Sharpe ratio is probably about the maximum possible return over a given 30 month period. If volatility just happened to go from 10 to 45 during this period, the annual return probably have been something more like -19%...

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