Individual investors can buy and sell S&P 500 Volatility Premium by selling options on the S&P 500. This can be done through a basic strategy involving selling options on the S&P 500, which may generate positive returns over the long run with medium risk. The S&P 500 volatility risk premium can be captured efficiently in the most liquid derivative markets globally. An investor or hedger purchasing an S&P 500 put option is transferring the equity market risk to the seller of the put option, who expects to be compensated through a systematic harvesting of the volatility premium. Instead of holding the S&P 500 as collateral, the put seller holds a cash-like position, such as short-term Treasuries, to purchase the S&P 500 from the option buyer if exercised.
Another way to trade the volatility risk premium is by buying exchange-traded funds (ETFs) and exchange-traded notes (ETNs) tied to the VIX. ETFs and ETNs related to the VIX include the iPath Series B VIX S&P 500 Dow Jones Indices. The Cboe Volatility Index, better known as VIX, projects the probable range of movement in the US equity markets above and below their current level in the immediate future. Specifically, VIX measures the implied volatility of the S&P 500 (SPX) for the next 30 days. When implied volatility is high, the VIX level is high, and the range of possible future price movements is wide.
Traders can also harvest the volatility risk premium by using options strategies such as short straddles, iron condors, and credit spreads. Delta-neutral options strategies, such as the short straddle, can also be used to harvest the volatility risk premium. Volatility tends to spike briefly, usually when the stock market slumps, followed by lengthier downward trends. Volatility clusters in regimes, and the best predictor of future volatility is current volatility.
The volatility risk premium can be thought of as the difference between the expected and realized volatility of the S&P 500. Just as we purchase insurance for homes and cars, investors can purchase insurance on their portfolios to hedge against unexpected market volatility. To investigate this further, a historical analysis of the VIX and S&P 500 indices can be conducted to see what happened to forward S&P 500 returns after a rise in volatility as measured by the VIX Index at various levels between 1990 and 2021.
In summary, individual investors can buy and sell S&P 500 Volatility Premium by selling options on the S&P 500, buying ETFs and ETNs tied to the VIX, and using options strategies such as short straddles, iron condors, and credit spreads to harvest the volatility risk premium.