Volatility Arbitrage Index via Variance Futures
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Solution Overview
Problem
Traditional trading systems, such as hedge funds, are associated with higher fees and lower liquidity compared to other investment types, and they do not effectively exploit the premium at which implied volatility of options trades in relation to their fair value.
Innovation Solution
A system and method that provides a volatility arbitrage index by tracking a short position in variance futures, allowing for a passively managed target index fund that holds cash collateral and periodically rebalances to account for gains or losses, thereby offering favorable returns with greater liquidity and transparency.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Productivity
If hedge funds are used to pursue investment schemes, then greater returns may be achieved, but fees are higher and liquidity is lower
Solution Approach 1:
The patent creates an index that copies the performance characteristics of a volatility arbitrage strategy without requiring actual active management. The index calculates a target value based on variance futures and cash collateral, providing a passive replication method that maintains liquidity while capturing the returns of the strategy.
Solution Approach 2:
The index serves itself by automatically calculating its target value through a defined formula that incorporates variance futures settlement values and cash collateral interest accruals. This self-calculating mechanism eliminates the need for active fund management while maintaining the strategy's return profile.
2Productivity
If hedge funds are used to pursue investment schemes, then greater returns may be achieved, but fees are higher
Solution Approach 1:
The index replicates the volatility arbitrage strategy's returns through a passive calculation method, eliminating the need for expensive active fund management. By using a formula-based approach with variance futures and cash collateral, the index captures strategy returns without incurring hedge fund fee structures.
Solution Approach 2:
The index automatically determines its target value through a predefined calculation process, eliminating the need for paid fund managers. The system self-manages by calculating the target index value based on variance futures settlement values and cash collateral performance.
3Ease of operation
If a target index fund holds short positions in variance futures with cash collateral, then favorable returns with greater liquidity are provided, but the system complexity increases
Solution Approach 1:
The index creates a simplified representation of the volatility arbitrage strategy through mathematical calculation rather than actual complex trading operations. By copying the strategy's economic outcomes through a formulaic approach, the index provides liquidity without requiring the operational complexity of managing actual short positions and collateral.
Solution Approach 2:
The index acts as an intermediary that translates the complex volatility arbitrage strategy into a simple, liquid investment vehicle. The target index value serves as a mediator between the underlying variance futures market and investors, providing exposure to the strategy without direct participation in its operational complexity.
Data Source
AI summary
A system comprises a memory operable to store a first closing value of an index for a first day, wherein the index is based at least in part on a cash account and a variance future. The system further comprises a processor communicatively coupled to the memory and operable to determine a first settlement value of a variance future for the first day and to determine a second settlement value of the variance future for a second day. The processor is further operable to determine an increase of cash in the cash account from the first day to the second day, wherein the determination is based at least in part on an interest rate. The processor is further operable to determine a second closing value of the index for the second day, wherein the determination is based at least in part on the determined increase of cash in the cash account, the first settlement value, and the second settlement value. The processor is further operable to store the second closing value in the memory.