The strategy of changing the moneyness in response to recent volatility is similar to the strategy of Moreira & Muir (2017), Volatility-managed portfolios, Journal of Finance.
The issue with this type of volatility timing in the market is that most of the results come from avoiding a small number of bad events and historical performance relies on getting the timing right for those historical events (I have a breakdown of these timings in a draft/note here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3832340).
In your strategy the size of the periodic drawdown is going to be very sensitive to the moneyness of the puts sold when the music stops and a market crash happens.
I found with the vol timing strategy, if historically you re-balance mid-month rather than at the end of the month, then the performance disappears. Is this because there is something special about end-of-month re-balancing that guarantees this timing or is it because the timing just happened to line up with a few negative market events historically?
If it's the latter there is a good chance the next crash might not be timed correctly, you will be writing closer to the money puts, and past performance will not reflect future returns!
Hi Joachim,
The strategy of changing the moneyness in response to recent volatility is similar to the strategy of Moreira & Muir (2017), Volatility-managed portfolios, Journal of Finance.
The issue with this type of volatility timing in the market is that most of the results come from avoiding a small number of bad events and historical performance relies on getting the timing right for those historical events (I have a breakdown of these timings in a draft/note here: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3832340).
In your strategy the size of the periodic drawdown is going to be very sensitive to the moneyness of the puts sold when the music stops and a market crash happens.
I found with the vol timing strategy, if historically you re-balance mid-month rather than at the end of the month, then the performance disappears. Is this because there is something special about end-of-month re-balancing that guarantees this timing or is it because the timing just happened to line up with a few negative market events historically?
If it's the latter there is a good chance the next crash might not be timed correctly, you will be writing closer to the money puts, and past performance will not reflect future returns!