The active management process of adjusting a portfolio’s exposure to implied volatility, specifically by trading options or other volatility-sensitive derivatives. This strategy aims to neutralize or target a specific Vega value, managing the portfolio’s sensitivity to changes in market volatility.
Mechanism
Vega rebalancing operates by calculating the portfolio’s aggregate Vega, which measures its sensitivity to a one-percent change in implied volatility. When this aggregate Vega deviates from a target range, typically zero for volatility-neutral strategies, algorithms generate trades in options or other volatility products to bring the Vega back within bounds. The mechanism relies on real-time implied volatility surface data, accurate options pricing models, and high-speed execution capabilities to minimize slippage and transaction costs during rebalancing trades. This process often involves dynamic adjustments as market conditions and options prices change.
Methodology
The strategic methodology involves defining a target Vega exposure, which could be neutral, positive, or negative, based on the investor’s outlook on future volatility. This requires continuous monitoring of implied volatility levels across relevant digital asset options. Quantitative models assess the Vega contribution of each options position and calculate the necessary adjustment trades. Rigorous risk management includes stress testing the portfolio’s Vega exposure under various volatility shocks and accounting for the costs associated with frequent rebalancing, ensuring the strategy effectively manages volatility risk without excessive transaction drag.
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