Abstract
We propose a novel non-structural method for hedging European options, relying on two model-independent results: First, under suitable regularity conditions, an option price can be disentangled into a linear combination of risk-neutral moments. Second, there exists an explicit approximate functional form linking the risk-neutral moments to the futures price of the underlying asset and the related variance swap contracts. We show that S&P 500 call prices are mainly explained by two factors that are related to level and volatility of the underlying index. We empirically compare the performance of two strategies where the vega exposure is adjusted either by a direct position in a variance swap contract or, indirectly, through an at-the-money call. While both strategies ensure effective immunization in periods of market turmoil, taking direct exposure on variance swaps is not optimal during extended periods of subdued volatility.
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