Let's talk Realized Vol...

If there is one single most important number that we, as volatility traders, look at, it's realized vol.

The problem with realized vol is that it's one of the most biased estimators... Give two traders identical time-series and get 4 RVs

The reason this estimator is so biased is because it's highly sensitive to both sampling frequency and size (window).

Also, we can get very different result if we sample based on close-close or OHLC (open-high-low-close).


So why do we use such a biased estimator, as it tends to over/underestimate the "true" realized volatility in most cases?

Over the years I came to a realization that although possible to come up with an unbiased realized variance estimator


The practical application for such estimator are pretty limited (from modeling perspective it does serve some purpose for these who are into fractal models such as rough volatility).

Let's think about dynamic hedging... Dynamic hedging is highly path dependent process

Which means that under different types of realized vol estimators we will get different gamma profile -> different realized PnL.

As not all vol traders/strategies were created equal applying the "best fitted" estimator to our trading style is crucial to its success.
One of the fields which I researched endlessly (and still researching) is dynamic hedging, as I made it my goal to find the ultimate dynamic hedging strategy (and have yet to come up with such).
A while back I wrote about a toy-strategy that I used to base my current dynamic hedging process on. This, however, merely scratches the surface of dynamic hedging modeling/strategies.

Feel free to share your thoughts/comments..


• • •

Missing some Tweet in this thread? You can try to force a refresh

Keep Current with Harel Jacobson

Harel Jacobson Profile picture

Stay in touch and get notified when new unrolls are available from this author!

Read all threads

This Thread may be Removed Anytime!


Twitter may remove this content at anytime! Save it as PDF for later use!

Try unrolling a thread yourself!

how to unroll video
  1. Follow @ThreadReaderApp to mention us!

  2. From a Twitter thread mention us with a keyword "unroll"
@threadreaderapp unroll

Practice here first or read more on our help page!

More from @VolQuant

25 Feb

A shift in volatility/correlation regime has been boiling beneath the surface over the last few weeks, and while many are solely focused on one market segment, my mandate of cross-asset volatility comes in handy watching this situation unfolds

Let's start by stating the obvious - the narrative right now is driven by the steepening of the yield curve (led by the selloff in long-end bonds). I will not make any argument whether this is justified or not, as I'm a very bad macro trader, but this steepening governs

the market dynamic for two reasons: 1. it correlates to forward inflation expectations (some reflexive dynamic is definitely going on there), 2. it accelerates the rotation trade in equities (and overweight growth stocks).
Read 8 tweets
19 Feb
Gamma-Theta-Vol triangle

The entire concept of volatility trading can be simplified into a triangular relationship between Vol-Gamma-Theta.

Although it might seems oversimplifying a rather complex dynamic of option trading, your realized pnl will be determined by that triangle
Let's understand how this three-way relation affects your option trading pnl...

We know that volatility determines the cost of the option, so to have a profitable option strategy we first need to be on the right side of the trade (buying cheap vol, and selling rich vol), but
once we traded the option we enter the gamma-theta phase of running the day-to-day risk of our strategy...

Our premiums (paid or received) are given at inception, and we can think of the option premium as a series of T interval straddle breakeven, so to be profitable we need
Read 8 tweets
15 Feb
What drives the $EUR?
cc @o_wutang

FX risk-on/risk-off drivers might be misleading when it comes to $EUR. While long-lasting correlations (such as the JPY,CHF/risk-off) might play role in FX drivers, the EUR correlation is probably the biggest misconception
practitioners have. imo EUR drivers are more funding related than risk-on/risk-off (if anything it's negatively correlated to equities, or positively correlated to vstoxx/vix movements).

The root of this misconception lies in the fact that traders/investors have a long
memory, and remember how EUR behaved after the GFC and through the sovereign credit crisis.

Since then, both the ECB and the European Council have done a lot to safeguard the EU (or at least kicking the can down the road), so the EUR became less risky currency
Read 5 tweets
13 Feb
Crash Course in Risk Management

My affair with quant finance began back in 2007. Back then I was a BA student who just started his first steps in the derivatives market. Needless to say that I was about to witness a defining moment in financial markets, as the GFC was just
around the corner. In 2008 I was already in my transition from the pricing side to the trading side. Although I always thought I will end up being a risk manager, my career was stirred toward trading.

I started trading (not officially though) two weeks before Lehman went
under. That period was crazy, but not because of market volatility, but because we were witnessing something that was unthinkable - banks that are unwilling to trade with each other (and betting on their peers to go under).

To understand financial markets we need to look beyond
Read 5 tweets
6 Feb

Trading lessons from the boxing gym

Anyone who has been following me for a while knows my two greatest passions are quant trading and boxing, and I often find both to have great similarities....

Over the years I've learned a lot of priceless trading lessons in the gym

and one of the most important lessons I've learned is "box your style"

When I started boxing I had a heavyweight coach. This guy was a true champion, gifted boxer, who went toe-to-toe with the bests of the best. The only problem was that I'm a lightweight boxer (135lb)
As long as I was learning the fundamentals I had not problems. Had solid foundations (punches, footwork, head movement) so I thought that I will kill it in sparring. That was when I found out my biggest flaw - my boxing style

Because my coach was a big guy his style was
Read 9 tweets
2 Feb
Basis Risk explained

Practitioners usually look at risk factors of a single underlying/portfolio (volatility, trend, VaR, etc...), but more often than not our bigger risk is a risk that we tend to overlook "Basis Risk".

In short - Basis Risk is a risk of imperfect hedge

If that sounds all to vague, let's look at a simple example : our portfolio holds short VIX-Feb and long VIX-Mar. Obviously if the SPX sells off they will both react to the move in spot VIX (as a byproduct of the spot-vol correlation), but each will react with different magnitude
The difference in the two futures' reaction function is the driver of the basis risk. even if we hold net zero position, our P&L will be affected by the dynamic of the spread between the two, hence, the position is imperfectly hedged.
Read 11 tweets

Did Thread Reader help you today?

Support us! We are indie developers!

This site is made by just two indie developers on a laptop doing marketing, support and development! Read more about the story.

Become a Premium Member ($3/month or $30/year) and get exclusive features!

Become Premium

Too expensive? Make a small donation by buying us coffee ($5) or help with server cost ($10)

Donate via Paypal Become our Patreon

Thank you for your support!

Follow Us on Twitter!