Volatility Timing Using ETF Options: Evidence from Hedge Funds
Abstract
We find that hedge funds’ ETF option positions predict cross-sectional differences in the future volatility of underlying ETFs. The predictive power is strongest for straddle positions and non-equity ETFs. A tracking portfolio of straddles based on funds’ straddle positions earns quarterly abnormal returns of 7.35%. Net of fees, funds using ETF straddles deliver lower risk and higher benchmark-adjusted returns than nonusers. We also find that hedge funds’ trading in ETF options has a positive impact on ETF option prices and improves price efficiency in individual equity options. We conclude that ETF options are an important venue for informed volatility trading.
Authors
George O. Aragon Arizona State University (ASU) - Finance Department
Shuaiyu Chen Purdue University - Krannert School of Management
Zhen Shi Georgia State University