Zero-Cost Collar Strategy

Zero-Cost Collar (ZCC) is an ideal strategy for hedging downside risks in long-term stock positions that realize large capital gains. This strategy consists of three components: (1) holding an underlying asset (stock portfolio), (2) buying out-of-pocket (OTM) put options (downward protection), and (3) selling out-of-pocket call options on the same maturity date (put option cost offset).

The core of ZCC is to offset the cost of buying put options using the premium obtained from selling call options. Through this, investors secure downward protection (loss limit) at low costs, but at the same time, they must give up the rising profits of the stock price above the call option exercise price (setting an upper limit on profits).

Analyzing the Impact of Color Strategy on VIX Output

When strategies such as ZCC are widely implemented in the market, the interpretation of the VIX index becomes complicated. This strategy puts opposite pressure on the two components of the VIX:

Buying Put Options (VIX Rising Factor): A large buy of OTM put options for downside risk defense increases the intrinsic volatility (IV) of those put options, putting upward pressure on VIX.

Call Options Selling (VIX Decline Factor): The selling of OTM call options to offset the cost of buying put options lowers IV of those call options, putting downward pressure on VIX.

The net effect of this dual pressure can dilute or underestimate the extent of the VIX’s rise. This is related to the option’s intrinsic volatility smile/smirk phenomenon and VRP distribution. Even if ZCC is nominally “zero cost,” the structural negative alpha (VRP payment) arising from the purchase of put options often exceeds the positive alpha obtained from the sale of call options. As a result, large-scale ZCC positions can distort the actual level of fear in the market by partially offsetting the rise of the VIX due to the call selling premium, even though there is a serious downside risk avoidance demand (put buying) in the market. For this reason, an important analytical limit arises that it is difficult to accurately measure the pure demand for downside risk with VIX alone.

Direct Volatility Hedging with VIX Derivatives

Hedge funds can trade VIX futures and options directly instead of underlying index options to take on pure volatility exposure, which provides significant flexibility in market risk management.

The Role of VIX Call Options: Buying VIX call options is used as an effective hedge against a surge in volatility when the S&P 500 plunges. By buying VIX call options, investors can defend against losses in their stock portfolio by betting on the rise of volatility itself. In particular, these hedging strategies

Tail Risk, or Lottery Tickets, acts as a lottery against extreme market shocks.

Duality of Elaborate Institutional Position: Recent market trends show that hedge funds maintain record net short positions against VIX futures while aggressively buying VIX call options. Net selling of VIX futures is a strategy to acquire VRP in the long run and pursue stable returns. However, this strategy can expose you to unlimited risks in the event of a volatility surge. Thus, hedge funds purchase OTM VIX call options to defend against an extreme volatility shock while pursuing profits through selling VIX futures, optimizing hedging costs and effectively managing tail risk.

Complementary Relationship between VIX and SKEW

If the VIX index measures the market’s total volatility width, or square root of variance, to show a general level of risk, SKEW measures the degree to which volatility is downside preference, or how much the market values downside risk. Therefore, even if the VIX remains at a stable low level, if the SKEW index is high, this means that

On the surface, the market looks calm, but it can be interpreted as a hidden warning sign that large institutions are steadily buying insurance against a catastrophic fall behind the scenes.

Definition and Mechanism of VVIX

The VVIX (Cboe VIX of VIX Index) measures the expected volatility of the VIX index itself, that is, the volatility of Volatility (Volume of Vol). VVIX is calculated in the same way as the VIX calculation methodology using the price of the VIX option as an input, and indicates how rapidly the price of the VIX will change over the next 30 days. If the VIX represents the ‘Velocity’ of investor fear, the VVIX can be understood as an indicator of how quickly the fear will change, that is, the ‘Acceleration’.