CAIA - 30 - Volatility, Correlation, and Dispersion Products

Question 1

___ ___are pure plays on volatility with returns that are driven directly by exposure to the volatility factor.

Answer 1

Volatility derivatives are pure plays on volatility with returns that are driven directly by exposure to the volatility factor.

Question 2

Investments that tend to decline with increases in return volatility are said to be ___ volatility and have a ___risk premium.

Answer 2

Investments that tend to decline with increases in return volatility are said to be short volatility and have a positive risk premium.

Question 3

Studies show that volatility ___ a unique risk factor.

Answer 3

Studies show that volatility is a unique risk factor.

Question 4

An options ___ is the length of time until the contract expires

Answer 4

An options tenor is the length of time until the contract expires

Question 5

The time decay of options decreases at the ___ ___of ___.

Answer 5

The time decay of options decreases at the square root of time.

Question 6

A ___ ___ combines a short call and a short put on the same asset with the same strike price.

Answer 6

A short straddle combines a short call and a short put on the same asset with the same strike price.

Question 7

A ___ ___combines a short call and a short put on the same asset, with different strikes.

Answer 7

A short strangle combines a short call and a short put on the same asset, with different strikes.

Question 8

At-the-money straddles have ___ market beta.

Answer 8

At-the-money straddles have zero market beta.

Question 9

A short ___ ___ involves selling an out-of-the-money bull spread and an out-of-the money bear spread.

Answer 9

A short iron condor involves selling an out-of-the-money bull spread and an out-of-the money bear spread.

Question 10

A short ___ ___ involves selling a bull spread and a bear spread with the same middle strike price.

Answer 10

A short iron butterfly involves selling a bull spread and a bear spread with the same middle strike price.

Question 11

___ reflects the effects of declines in return volatility of the underlying asset and ___directly reflects the passage of time. These two measures are ___ correlated.

Answer 11

Vega reflects the effects of declines in return volatility of the underlying asset and theta directly reflects the passage of time. These two measures are highly correlated.

Question 12

Options with higher vega have ___ gammas and ___thetas. An option with higher vega decays ___each day than one with lower.

Answer 12

Options with higher vega have lower gammas and higher thetas. An option with higher vega decays more each day than one with lower.

Question 13

___ risk can be reduced by hedging a call position with a short position in the underlying asset.

Answer 13

Delta risk can be reduced by hedging a call position with a short position in the underlying asset.

Question 14

___-neutral hedged option positions are a play on the volatility of the option’s underlying asset.

Answer 14

Delta-neutral hedged option positions are a play on the volatility of the option’s underlying asset.

Question 15

Delta-neutral portfolios that are long options are ___ gamma.

Answer 15

Delta-neutral portfolios that are long options are long gamma.

Question 16

To keep a long gamma portfolio hedged, traders ___ as the stock price falls and ___as it rises.

Answer 16

To keep a long gamma portfolio hedged, traders buy as the stock price falls and sell as it rises.

Question 17

If realized volatility exceeds the initial vega, then positive effects of long ___ dominate the effects of ___and the position experiences a ___.

Answer 17

If realized volatility exceeds the initial vega, then positive effects of long gamma dominate the effects of theta and the position experiences a gain.

Question 18

Infrequent rebalancing is a bet that volatility will be ___.

Answer 18

Infrequent rebalancing is a bet that volatility will be directional.

Question 19

Realized volatility ___-___, ___and has a ___ ___.

Answer 19

Realized volatility mean-reverts, clusters and has a long memory.

Question 20

Volatility is often modeled using ___ ___ ___ ___ and ___ ___ models.

Answer 20

Volatility is often modeled using generalized autoregressive conditional heteroscedasticity (GARCH) and regime switching models.

Question 21

An ___ ___ ___ represents several vegas relative to their tenor, moneyness or type.

Answer 21

An implied volatility structure represents several vegas relative to their tenor, moneyness or type.

Question 22

A vega structure that focuses on the relationship between vegas and moneyness is a ___ ___.

Answer 22

A vega structure that focuses on the relationship between vegas and moneyness is a volatility skew.

Question 23

An option’s ___ ___ is a graphical representation of vega for several options with different expiration dates and strike prices.

Answer 23

An option’s volatility surface is a graphical representation of vega for several options with different expiration dates and strike prices.

Question 24

Volatility strategies have recovered from drawdowns in less than ___ year, which contrasts with long-only stocks, credit, or commodity investments that can take ___-___ years.

Answer 24

Volatility strategies have recovered from drawdowns in less than 1 year, which contrasts with long-only stocks, credit, or commodity investments that can take 1-2 years.

Question 25

Mean reversion in realized volatility (is/is not) aribtragable.

Answer 25

Mean reversion in realized volatility **is not** aribtragable.

Question 26

A ___ \_\_\_is a process that is used to model values that may experience large discrete changes.

Answer 26

A **jump process** is a process that is used to model values that may experience large discrete changes.

Question 27

\_\_\_ \_\_\_is the risk of continuous accrual of small changes in an asset's volatility over time.

Answer 27

**Volatility diffusion** is the risk of continuous accrual of small changes in an asset's volatility over time.

Question 28

A ___ \_\_\_refers to the risk of large, sudden increases in voalitility.

Answer 28

A **volatility jump** refers to the risk of large, sudden increases in voalitility.

Question 29

Continuous time diffusion process for returns (equation)

Answer 29

Question 30

A ___ \_\_\_occurs when the observed behavior of a financial series undergoes a significant change.

Answer 30

A **regime change** occurs when the observed behavior of a financial series undergoes a significant change.

Question 31

While quoted yields are used to calculate bond prices, quoted ___ \_\_\_ is used to calculate options and volatility swap prices.

Answer 31

While quoted yields are used to calculate bond prices, quoted **implied volatility** is used to calculate options and volatility swap prices.

Question 32

Bond prices and volatility products are both driven by \_\_\_-\_\_\_factors.

Answer 32

Bond prices and volatility products are both driven by **mean**-**reverting** factors.

Question 33

Volatility and interest rates both have a ___ structure.

Answer 33

Volatility and interest rates both have a **term** structure.

Question 34

\_\_\_ of volatility and \_\_\_of bonds both require compensation for their risk.

Answer 34

**Sellers** of volatility and **buyers** of bonds both require compensation for their risk.

Question 35

A ___ \_\_\_involves a variance buyer making a payment based on a predetermined variance level and receiving an asset's annual realized variance.

Answer 35

A **variance swap** involves a variance buyer making a payment based on a predetermined variance level and receiving an asset's annual realized variance.

Question 36

Variance swap payoff (equation)

Answer 36

Swap notional value \* (Realized variance - strike variance)

Question 37

The ___ \_\_\_ ___ is a market-based estimation of the 30-day implied volatility of the S&P 500

Answer 37

The **CBOE Volatility Index** (VIX) is a market-based estimation of the 30-day implied volatility of the S&P 500

Question 38

Calculation of the VIX uses a ___ \_\_\_ of S&P options. The variance swap rate is calculated immediately prior to and after ___ days. The VIX is the ___ \_\_\_ of the two variance rates.

Answer 38

Calculation of the VIX uses a **weighted avg** of S&P options. The variance swap rate is calculated immediately prior to and after **30** days. The VIX is the **square root** of the two variance rates.

Question 39

The VIX ___ \_\_\_is the geographical representation of the relationship between prices of vix futures contracts and their settlement dates.

Answer 39

The VIX **term structure** is the geographical representation of the relationship between prices of vix futures contracts and their settlement dates.

Question 40

The term structure of the VIX is generally in \_\_\_.

Answer 40

The term structure of the VIX is generally in **contango**.

Question 41

A ___ \_\_\_ is a derivative contract that transfers the risk between two parties that the average correlation among a set of stocks differs from the swap's strike correlation.

Answer 41

A **correlation swap** is a derivative contract that transfers the risk between two parties that the average correlation among a set of stocks differs from the swap's strike correlation.

Question 42

Correlation swap payoff (equation)

Answer 42

Swap Notion Value \* (Avg Corr - Strike Corr)

Question 43

Empirical research shows that implied correlations tend to be ___ relative to historical correlation.

Answer 43

Empirical research shows that implied correlations tend to be **overpriced** relative to historical correlation.

Question 44

Owning a correlation swap during a crises is typically \_\_\_.

Answer 44

Owning a correlation swap during a crises is typically **profitable**.

Question 45

To make a ___ trade, sell the volatility of the index and buy the volatility of the index components.

Answer 45

To make a **dispersion** trade, sell the volatility of the index and buy the volatility of the index components.

Question 46

A ___ spread is a combination of long calls and short calls on the same underlying asset with the same expiration date but different strike prices. It is a type of skew spread.

Answer 46

A **vertical** spread is a combination of long calls and short calls on the same underlying asset with the same expiration date but different strike prices. It is a type of skew spread.

Question 47

A ___ \_\_\_is a vertical spread with unequal numbers of long and short option positions.

Answer 47

A **ratio spread** is a vertical spread with unequal numbers of long and short option positions.

Question 48

A ___ vertical spread is created using the same number of long and short positions

Answer 48

A **pure** vertical spread is created using the same number of long and short positions

Question 49

A ___ spread is buying at the money puts and selling out of money puts and benefits if the asset value \_\_\_.

Answer 49

A **bear** spread is buying at the money puts and selling out of money puts and benefits if the asset value **declines**.

Question 50

A ___ spread trade is buying at the money calls and selling out of the money calls and benefits if the underlying asset value \_\_\_.

Answer 50

A **bull** spread trade is buying at the money calls and selling out of the money calls and benefits if the underlying asset value **increases**.

Question 51

\_\_\_ \_\_\_occur because differences between implied volatilities of options with different strike prices. To exploit these differences, a traditional vertical spread strategy ___ OTM options with higher IV than at the money options.

Answer 51

**Volatility skews** occur because differences between implied volatilities of options with different strike prices. To exploit these differences, a traditional vertical spread strategy **sells** OTM options with higher IV than at the money options.

Question 52

Vertical spreads commonly used in equities with delta hedging involve ___ ATM puts and \_\_\_OTM puts.

Answer 52

Vertical spreads commonly used in equities with delta hedging involve **buying** ATM puts and **selling** OTM puts.

Question 53

A ___ spread trade is a combination of long calls and short calls on the same underlying asset with the same strike but different expiration dates.

Answer 53

A **horizontal** spread trade is a combination of long calls and short calls on the same underlying asset with the same strike but different expiration dates.

Question 54

Horizontal spread trades have ___ exposure to changes in the underlying assets than vertical spread trades.

Answer 54

Horizontal spread trades have **less** exposure to changes in the underlying assets than vertical spread trades.

Question 55

For a horizontal spread trade, if the short-term option IV is expected to increase relative to the long-term option IV, then the strategy ___ the short-term options and ___ the longer-term options.

Answer 55

For a horizontal spread trade, if the short-term option IV is expected to increase relative to the long-term option IV, then the strategy **buys** the short-term options and **sells** the longer-term options.

Question 56

Payoffs on horizontal spread trades is ___ certain than vertical spread trades.

Answer 56

Payoffs on horizontal spread trades is **less** certain than vertical spread trades.

Question 57

An \_\_\_-\_\_\_ option spread involves a long option position in one asset and a short option position in another asset.

Answer 57

An **inter**-**asset** option spread involves a long option position in one asset and a short option position in another asset.

Question 58

Inter-asset option spreads are ___ when volatility is high and ___ when volatility is low.

Answer 58

Inter-asset option spreads are **high** when volatility is high and **low** when volatility is low.

Question 59

\_\_\_ is an option prices' sensitivity to a unit change in the underlying asset's volatility or the option's IV.

Answer 59

**Vega** is an option prices' sensitivity to a unit change in the underlying asset's volatility or the option's IV.

Question 60

Vega (Equation)

Answer 60

Question 61

The ___ \_\_\_index is designed to extract the volatility or correlation risk premium.

Answer 61

The **short volatility** index is designed to extract the volatility or correlation risk premium.

Question 62

The ___ \_\_\_index is designed to profit during market declines.

Answer 62

The **long volatility** index is designed to profit during market declines.

Question 63

The ___ \_\_\_ \_\_\_index is designed to capitalize on volatility mispricings.

Answer 63

The **relative value volatility** index is designed to capitalize on volatility mispricings.

Question 64

The ___ \_\_\_ ___ index is designed to protect against large broad market declines

Answer 64

The **tail risk hedge** index is designed to protect against large broad market declines

Question 65

Long volatility and tail risk indices are ___ volatile than short volatility or long volatility indices.

Answer 65

Long volatility and tail risk indices are **more** volatile than short volatility or long volatility indices.

Question 66

Relative value, short and long volatility strategies have ___ correlations.

Answer 66

Relative value, short and long volatility strategies have **low** correlations.

Question 67

Relative value volatility strategies have ___ net vega exposure.

Answer 67

Relative value volatility strategies have **small** net vega exposure.

Question 68

Long volatility funds tend to have ___ correlation with tail risk funds.

Answer 68

Long volatility funds tend to have **high** correlation with tail risk funds.

Question 69

Long volatility strategies are ___ aggressive than tail risk strategies.

Answer 69

Long volatility strategies are **less** aggressive than tail risk strategies.

Question 70

Unlike tail risk funds, long volatility funds (do/ do not) have a mandate to provide protection at all times.

Answer 70

Unlike tail risk funds, long volatility funds **do not** have a mandate to provide protection at all times.

Question 71

A ___ \_\_\_is defined as an event/occurrence that deviates beyond that which is expected and that is extremely difficult to predict.

Answer 71

A **black swan** is defined as an event/occurrence that deviates beyond that which is expected and that is extremely difficult to predict.

Question 72

Long volatility strategies have a ____ drag on performance due to ____ costs.

Answer 72

Long volatility strategies have a **large** drag on performance due to **high** costs.