There’s a balance to be struck between the number of observations and trading costs – the first live iteration uses multiple intraday fixes, while a big data algorithm aims to maximise execution quality. Back-tests show the approach can slash short-term vol-of-vol three-fold, while gap risk can be reduced by as much as 70% depending on the speed of the algorithm, Souli says. The new approach also delivered 1.7 percentage points of improvement when compared to a traditional vol target index – again, in back-tests.
The client was pleased with the result. “Their engineers put together a fantastic solution,” says the firm’s product head, noting a triple-whammy of benefits. In addition to addressing the capacity issue, the innovative way of managing volatility translates into cheaper options for the client. An unexpected, though welcome benefit of the vol control was an improved the Sharpe ratio of the underlying.
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