Volatility Dependent Structured Products

Abstract

We construct a derivative that depends on the SPY and VIX and, in this way, incorporates both the market risk premium and the variance risk premium. We show that the product’s Sharpe ratio is higher than the SPY Sharpe ratio. If we had invested $10,000 into the product, the product’s payoff would have been about $60,000 at the end of 2018. In comparison, if we invested $10,000 into the SPY, the SPY payoff would be only about $30,000.

TOPICS: Asset-backed securities, real assets/alternative investments/private equity, CLOs, CDOs, and other structured credit, analysis of individual factors/risk premia, derivatives

Key Findings

• ▪ We construct a volatility dependent derivative (product) that includes the SPY and the in-the-money VIX put option.

• ▪ The product incorporates both the market risk premium and the variance risk premium.

• ▪ The Sharpe ratio of the product is higher than the Sharpe ratio of the SPY.