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February 1, 2021

The Law of One Price in Equity Volatility Markets

Peter Van Tassel and Charles Smith

Can option traders take a square root? Surprisingly, maybe not. This post shows that VIX futures prices exhibit significant deviations from their option-implied upper bounds—the square root of variance swap forward rates—thus violating the law of one price, a fundamental concept in economics and finance. The deviations widen during periods of market stress and predict the returns of VIX futures. Just as the stock market struggles with multiplication, the equity volatility market appears unable to take a square root at times.

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Posted at 7:00 am in Financial Markets | Permalink

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