The changing equity derivatives landscape
When describing option costs, we often speak of the spread between implied and realised volatility as the risk premium embedded in option prices. Though this spread tends to be positive, option buyers look to minimise it and lessen the overall cost of an option. When implied volatility rises, as it has recently, the potential for overpaying for an option increases as well. When one-month SPX implied volatility was offered at 10 implied vol, option buyers faced little risk of overpaying for options in volatility terms: realised did not drop too far below 10. Now that SPX implieds are trading in the mid-30s and the VIX Index (SPX implied volatility index) has reached as high as 42, the risk of overpaying for options has increased. Consumption options provide similar upside/downside exposure as vanilla options, with almost no exposure to volatility. Consumption options are most effective when implieds are trading at a premium to realiseds, when no volatility market exists or in instances when traders prefer to express a fundamental view without gaining exposure to implied volatility.