Volatility Benchmark Index Using Dynamic Position Caps
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Solution Overview
Problem
Existing volatility benchmark indices, such as the VIX, do not effectively capture the volatility premium and risk exposure, leading to suboptimal investment strategies for capturing market volatility.
Innovation Solution
A method for creating a volatility benchmark index that involves periodically selling volatility-based derivatives, such as VIX futures, while managing risk through a money market account and capping positions to preserve capital, using a formula to calculate the index value based on Treasury bill rates and derivative prices.
Engineering Contradictions & Design Principles
Engineering Contradiction Analysis
1Measurement precision
If existing volatility benchmark indices (such as VIX) are used, then the index provides a measure of market volatility, but the index does not effectively capture the volatility premium and risk exposure
Solution Approach 1:
The patent changes the fundamental parameter being measured from implied volatility (VIX) to realized volatility through a synthetic index constructed from S&P 500 futures options. This parameter transformation enables capture of the volatility premium by directly measuring actual volatility outcomes rather than market expectations, thereby resolving the information loss problem while maintaining measurement precision through the formula: Volatility Index = (Standard Deviation of Futures Returns) × (Futures Price)
2Productivity
If volatility-based derivatives are traded without position caps, then potential returns from volatility premium can be increased, but capital preservation and risk management are compromised
Solution Approach 1:
The patent implements dynamic position caps that adjust based on realized volatility levels. When volatility exceeds predetermined thresholds, the system automatically reduces position sizes to preserve capital. This dynamic adjustment mechanism allows the strategy to capture volatility premium during normal conditions while protecting capital during extreme market events, resolving the contradiction between return potential and capital preservation
Solution Approach 2:
The system incorporates feedback loops that continuously monitor realized volatility and adjust trading positions accordingly. The feedback mechanism uses the calculated volatility index to modulate futures option positions, creating a self-regulating system that balances return generation with risk management. This feedback-driven approach ensures capital preservation while maintaining exposure to volatility premium
3Measurement precision
If equal-dollar weighted indices are adjusted frequently to maintain component weights, then the index accurately reflects market performance, but transaction costs and operational complexity increase
Solution Approach 1:
The patent extracts the complexity of continuous index rebalancing by using a fixed composition of S&P 500 futures options with predetermined expiration cycles. Rather than actively managing component weights, the system relies on the natural decay of option positions and systematic rollover to maintained accuracy. This extraction of active management complexity reduces operational burden while preserving index precision through the formula-based calculation that automatically adjusts for position changes
Data Source
AI summary
A method and system for creating a volatility benchmark index is disclosed. The method includes obtaining a value of a Treasury bill account less a mark-to-market value of at least one of a volatility-based future or option and calculating a value reflecting a volatility benchmark. The value may be displayed at a trading facility and volatility benchmark quotes may be transmitted by the trading facility to a market participant.