Volatility-based strategy on Chinese equity index ETF options

Abstract

In recent years, there has been quick developments of derivative markets in China and standardized derivative trading have reached considerable volumes. In this research, we collect all the daily data of ETF options traded at Shanghai Stock Exchange and start with a simple short-volatility strategy. The strategy delivers nice performance before 2018, providing significant excess return over the buy and hold benchmark. However, after 2018, this strategy starts to deteriorate and no obvious risk-adjusted return is shown. Based on the discussion of relationship between the strategy's performance and market's volatility, we improve the model by adjusting positions and exposure according to volatility forecasts using methods such as volatility momentum and GARCH. The new models have improved performance in different ways, where larger upside capture and smaller drawbacks can be achieved in market fluctuation. This research has shown potentials of volatility-based trading on Chinese equity index options, and with further improvement and implementation considerations, real-world practical trading strategies can be formed.