Sophisticated volatility arbitrage hedge funds have started to research statistical volatility arbitrage as the next big money making strategy. "This is an untapped market," said one equity derivatives professional. He explained inefficiencies in the stock markets are actively exploited, but inefficiencies in the volatility markets are not, which creates opportunities for statistical volatility arbitrage.
Indeed, Maple Leaf Capital, a London-based hedge fund, already trades volatility, but is examining using a volatility statistical arbitrage model, according to Michael Wexler, ceo. He added, "The market conditions are quite good, with liquidity, high volumes and modest volatility."
One reason the market has not taken off so far is there have not been accurate trading models available. "The possibility of vol statistical arbitrage is very interesting to us, but [no effective models have] been produced in this area that I am aware of," said Paul Besson, a Paris-based volatility fund manager at CCR, a subsidiary of Commerzbank, with EUR200 million (USD247 million) under management.
A solution may have been found by Citigroup, which recently published research on index volatility spreads that can be used as a trading model. The model assesses current volatility spreads on two related indices in relation to an expected realized future volatility spread. Long/short option trades can then be executed when the model highlights anomalies. Officials at Citi declined comment.
Another hurdle to the development of the market has been that arbitrageurs have concentrated on more obvious areas, such as convertible bond arbitrage, but market saturation is causing opportunities in that field to dry up. This has lead fund managers to look for something new, explained an analyst with a U.S. house.