Our core philosophy at tasytrade is to sell premium. We want to sell volatility (especially when it’s high) and position ourselves to buy those options back when volatility contracts and option prices deflate. Furthermore, as Dylan Ratigan describes so succinctly, the “present fear of future uncertainty is overpriced”, which causes volatility’s systematic overstatement of expected moves to paint short options in an even better light. But, what if we’re wrong, and volatility goes up?
An expansion in volatility would obviously hurt a portfolio that is short premium or short volatility (vega). One way to add protection against an increase in volatility would be to simply buy volatility and inventory it for an indefinite period of time. Volatility products such as VXX, UVXY, or /VX could easily accomplish, but there is a significant cost, or drag, associated with these products.
Another way to accomplish the objective of shielding our portfolio against a pop in volatility would be to simply add short delta. As we know, prices and volatility typically have an inverse relationship, and so the short delta portion of our portfolio would benefit if volatility does indeed rise and prices fall. A core position that is short delta is a natural complement to a portfolio that is short premium. A delta neutral portfolio could also work, but is very difficult to execute, and a long delta portfolio wouldn’t make sense because then we are essentially doubling down on short volatility.
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