PurposeUsing volatility cones as the estimate of actual volatility instead of GARCH models, the purpose of this paper is to explore whether volatility arbitrage strategy can provide positive profits and how the transaction costs existed in the real market affect the effectiveness of volatility arbitrage strategy.Design/methodology/approachA number of hedging approaches proposed to improve the hedging results and final returns of Black-Scholes model are analyzed and compared.FindingsThe general finding is that volatility arbitrage strategy can provide satisfactory returns based on the samples in Chinese market. Regarding transaction costs, the variable bandwidth delta and delta tolerance approach showed better results. Besides, choosing futures together with ETFs as hedging underlying can increase the VaR for better risk management.Practical implicationsThis paper offers a new method for volatility arbitrage in Chinese financial market.Originality/valueThis paper researches the profitability of the volatility arbitrage strategy on ETF 50 options using volatility cones method for the first time. This method has advantage over the point-wise estimation such as GARCH model and stochastic volatility model.
China Finance Review International – Emerald Publishing
Published: May 15, 2017