Using VIX futures to hedge forward implied volatility risk

Abstract

The fair value of VIX futures is derived by pricing the forward 30-day volatility which underlies the volatility risk of S&P 500 in the 30days after the futures expiration. While forward implied volatility can also be traded with forward-start strangles, this study demonstrates that VIX futures could offer more effective volatility-risk hedge for an investor who has a short position on the S&P 500 futures call option. In particular, the delta-vega-neutral hedging strategy incorporating stochastic volatility on average outperforms in out-of-sample hedging. Adding price jumps further enhances the hedging performance during the crash period.