Isolating a risk premium on the volatility of volatility

Lorenzo Ravagli shows how to exploit a risk premium embedded in the vol of vol in out-of-the-money options

Volatility arrows

The author finds that for a class of stochastic volatility models, under the limits of zero skew, short maturity and near-the money, the implied lognormal volvol enters the dynamics of an option as a breakeven term corresponding to theVolga axis of risk: a non-zero Volga term monetises a P&L that is proportional to the differential of the squared values of implied and realised volvol.

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