Monetizing Variance Risk Premium with Index Options

There are certain structural inefficiencies in the options market that are not widely known amongst traders, one of which is the variance risk premium. With a PhD in physics from Stanford University and experience as a member of the technical staff at Bell Labs Lucent Technologies, Leo Valencia of has been researching and data-mining price variance patterns in index options for the past 24 years. In this MoneyMastersSM course, he will share his strategies for taking advantage of all the options inefficiencies he can find in the market and ways of exploiting them for profit.


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Leo Valencia, Options Analyst
Leo Valencia in an options analyst at and an electrical engineer with more than 20 years of experience in research and development projects. Mr. Valencia has been researching and data mining price variance patterns in index options for the past 24 years, and hosts his Gamma Optimizer service on ElliottWaveTrader, based on an application that helps traders pick the option strike and expiration that are most efficient for a particular move in the underlying. Taking information input by the user (underlying symbol, expected move, stop/risk, and timeframe), the Optimizer provides a listing of the best strike and expected returns.


Course Content

9 Chapters • 1:48:17 Duration
There are no free lunches in the market. Leo will quickly cover the most common misconceptions of options trading including the siren song of income generation and systematic premium selling among others.
In order to be a good options trader, it is very important to have a clear mental model of how options are priced. Leo will go over binomial pricing and the importance of variance during the pricing process, as well as the most common ways that risk is managed by options dealers.
Options dealers live in a risk-neutral world, but we retail traders live in the real world. That difference presents tremendous opportunity as structural inefficiencies can (and do) appear in certain markets. Here you’ll see why index options, and in particular SPX options, are so special and Leo will dive into the most important inefficiency present since the crash of 1987. In this section, he’ll introduce the volatility smile concept and the importance of skew.
The importance of the VIX index can’t be overstated. In this section Leo will go over what VIX actually represents, and you’ll see how future variance is always overestimated in SPX options. This is called the variance risk premium anomaly and it is what we want to monetize.
There are financial products that allow us to speculate directly with the variance risk premium in SPX without directional risk. Leo will cover the concepts behind variance swaps and variance futures. Buyer beware, this market is sadly outside the world of retail traders (mostly), but it is very helpful to have a good understanding on how they work.
By clever use of vanilla SPX options, you can design strategies that capture variance risk premium. All of them suffer from directional risk but Leo will go over risk mitigation and edges. He’ll go in detail about binary options replication and how to use them to extract variance risk premium.
Along with Leo, you’ll study a full naive (null hypothesis) strategy with vanilla SPX options that uses binary option replication to extract variance risk premium. This will be a detailed example with trade parameters, risk analysis, and historical performance of the strategy. Other naive strategies that are easy to implement will be provided.
Given that variance risk premium has been present since so long ago, it is possible to train neural nets to improve on all of the naive versions. In this section Leo will go over his proprietary ultra-convolution network, and how it is used to exploit structural inefficiencies in SPX.

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