To see further gains in volatility would require surprising outcomes from events such as the Fed and European Central Bank policy decisions next month, according to Credit Suisse Group AG. The euro sank to a seven-month low of $1.0617 this week on speculation the ECB will expand monetary stimulus in December, while expectations build that the Fed is set to boost rates. The shared currency was at $1.0690 as of 10:35 a.m. London time.
"Trading volatility can make money if there are mispricings in volatility," said Shahab Jalinoos, global head of foreign- exchange strategy in New York at Credit Suisse. “But now it’s not as obvious, because volatility is much higher than a year ago.”
‘More Art’
In Quaesta’s strategy, picking which options to buy or sell is only half the battle. In volatility trading, investors seek to cancel out delta, which represents the sensitivity of a derivative to changes in the value of its underlying asset. The goal is for the option position’s value to change based only on volatility.
Take the example of a trader who owns call options granting the right to buy euros against the dollar. The contract loses money if the shared currency depreciates. To offset the spot market’s influence on the position, the trader could sell euros periodically.
It can be an expensive process. Options that can be exercised at a price close to the prevailing exchange rate will cost about 50 percent of the trade’s notional value to hedge, according to Societe Generale SA.
Delta hedging should be "performed at every millisecond, so it’s not technically possible and you always have a residual risk," said Olivier Korber, a derivatives strategist at SocGen in Paris. "The hedging performance can be a loss, flat or even a gain. It is more art than science."