Futures on the Nasdaq-100 Volatility Index (VOLQ) open a new world of hedging and risk management for investors. They allow market participants to focus and execute an at-the-money (ATM) futures transaction to manage their Vega exposures and portfolio objectives.

This is a hypothetical example of how a trader could have traded during the month of August and September before VOLQ futures were listed on October 5, 2020. 

During the summer of 2020, a trader observed that the market was beginning to rally, but that Nasdaq-100 volatility fell to recently low levels. She was concerned that the lower level of volatility underpriced upcoming event risks, including election results, earnings announcements, and COVID-19 breakthroughs or setbacks that could cause large movement in the Nasdaq-100, either up or down, depending on potential outcomes.

To position for a higher volatility regime, the trader entered a long strangle position; a simultaneous purchase of a put and a call at slightly different strike levels that are usually slightly out-of-the money (OTM). In this hypothetical example, the trade was executed when the Nasdaq-100 was at 11,500 and volatility was below 30%. 

On Monday, August 17, 2020, she purchased eight strangles with strikes 11,000 / 12,000 on the Nasdaq-100 futures expiring on December 20, 2020. The position was composed of long eight 11,000-strike December puts and a long eight 12,000-strike December calls. The strangle position was priced to have volatility of 29%. Using a Black Scholes options pricing model, she saw that her strangle positions had 125 days until maturity on December 20, 2020, and the price of the strangles was 1,125. 

Her strategy was to capture upside exposure of implied volatility in the Nasdaq-100 Index options over the remaining weeks of summer and into autumn, even if the index itself will stay at roughly the same level. Over the following months, the Nasdaq-100 Index moved first up, and then down quite aggressively. This drove volatility higher. She had correctly predicted that the volatility regime would increase, and it did. With delta hedging, her position delivered a gain.

She knew that if the implied volatility of her position increases dramatically, she might be able to take advantage of the Vega exposure her portfolio has, even before the autumn. She still had a view that volatility could increase but, given her return, she wanted to have exposure in November when uncertainty might increase. She felt that over October, things might be calmer, and volatility could fall.  She was reluctant to sell her strangles prior to the actual election results and sought an effective and easily executable transaction for a portion of the remaining position’s term.

Using VOLQ futures, she can both capture some of the increase in implied volatility, while still maintaining her strangle position for her longer-term view.

Suppose that at the end of August and into early September, the price of VOLQ futures increased from 20 to 35. The increase in the option value due solely to the increase in implied volatility is attributed to Vega, which is the sensitivity of an option’s price to the level of implied volatility. 

Her eight December 11,000 / 12,000 strangles increased in price from 1,125 to 1,554, meaning her return from Vega was 429 points or $21,450 (429 points X $50/point). See Exhibit 2 for the detail payoff and selected Greeks.

Rather than simply selling out of her strangles, she can short the VOLQ futures at 39 and lock in the Vega return. This is particularly important to her because as the position moves towards expiry, the sensitivity of the strangle given a 1% to a move in volatility decreases. Exhibit 3 shows how this sensitivity decrease at a great rate over time.

If the implied volatility decreases back to below 30 either before or after the election, she can close out her VOLQ futures and have a reasonable exposure to volatility for the next few weeks.

On September 3, 2020, she begins to evaluate her position. She looks at the key dates and values that are important for her position. She would like to hedge the position over the period of October and then see how the strangle will behave in November. 

Her strangle options position remains eight 11,000 strike puts and eight 12,000 strike calls (in addition, she has futures used for delta hedging).  From Exhibit 4, she sees that the total Vega position for the strangle on September 3, 2020 is 50 points by multiplying the Vega amount by her total options position of 8 puts and calls she has a dollar Vega exposure of $20,000.

VOLQ has a multiplier of $1,000 times the implied volatility index and so a correlated hedge equivalent would be to short two VOLQ futures. The trader’s current strangle positions is long 20,000 Vega, and the VOLQ short of 2 contracts is short 20,000 Vega. The trader’s Vega position is now fully hedged.  

The trader shorted two contracts with volatility at 39. Over the following few weeks, the pre-election indications and COVID-19 updates witnessed market volatility fall. By September 15, 2020, VOLQ futures dropped in price to 33 and the corresponding implied volatility of the strangles also dropped 5 points.

VOLQ futures can offer a new and effective way to manage the Vega risk exposures of the Nasdaq-100.  There are three-month contracts listed to provide clear and tactical hedging risk for those parts of the volatility surface that traders need to hedge. This not only allows one to hedge near term Vega risk, but also forward volatility as well. 

In today’s dynamic world, this type of hedging is needed more than ever.

Nasdaq-100 Volatility Index (VOLQ) futures

Manage short-term volatility and protect against sharp movements on the Nasdaq-100 Index

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