Hedging Short Volatility Exposure

[dfwjf92jfd 40]

Here's a thought for the new year...

So imagine you've been doing VXX or SVXY diagonals, post-earnings condors, pre-earnings calendars, a short-vol SPX position, and some pre-earnings straddles. You take a look at your portfolio-wide volatility exposure and realize you've become net short...by a lot! I'm curious as to the methods (if any) people use to hedge their short volatility exposure in such a situation. What I'm hoping for is insurance (more than a normal profit-seeking trade) that you could put on quickly and easily adjust to protect against the sort of rapid, market-wide shock we've all been reading about. Of course, we'd love to set off all our short vol exposure using hedged straddles and the like, but what if this still doesn't restore a good balance...

The "naive" approach would be just to buy OTM calls on VIX. That has the obvious disadvantage of theta decay but the big benefit of simplicity, in addition to being something you can add/subtract/roll at any time. It can also be quite expensive... If you go this route, is there an optimal combination of strike price and expiration people use to achieve a target level of insurance? If you anticipate closing most of your positions within 30 days, should you do a 30+ day option and roll? Or should you buy a longer-term option and simply add/subtract as needed over time. Should we do something crazy like buy the June $22 calls?

Here's another thought: maybe the biggest concern is really rapid systemic downside risk, not a jump in volatility per se. Maybe what we're really concerned about is that a market-wide sell-off would happen much faster than further appreciation, making it more difficult to adjust in time... So what about buying OTM puts on SPX or RUT, while leaving the upside risk unhedged? Maybe there's another index that would be more appropriate for this strategy?

Finally, I'm curious whether people have a more efficient way of achieving the hedge than these approaches...

[akito 184]

I don't have any good ideas at the moment to contribute here, but just keep in mind that this topic is in the public forums, which is open to non-members.

[dfwjf92jfd 40]

Thanks for the note - we can move elsewhere if it would be more appropriate to discuss on the SO members' forum...

[Kim 7,513]

We will move if it becomes too specific.

For our official portfolio, we are just using the right mix of long and short vega strategies. If you have for example 60-70% exposure (the rest in cash), having 25-30% in straddles should provide a good balance. Also remember that pre-earnings calendars will benefit from sharp IV increase, so they will be more resilient to big moves.

One idea could be VIX backspread (something like buy 2 25 calls sell 1 20 call). It should benefit from sharp IV increase at very low cost (sometimes for a credit actually).