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LTCM was basically a bond Stat Arb shop…. Using leverage to enhance their returns.

Let’s say we wanted to replicate a similar trading strategy of LTCM but using volatility as the underlying asset. The asset we are going to “trade” is the volatility spread between VIX and the GARCH (1,1) S&P 500 volatility. We are going to start this portfolio with $10mm and trading begins in January 2018 and ends March 31st 2021 using 5 to 1 leverage….

Here are the rules:

At the start of each month you will sell next month’s ( so in January you would sell a Feb maturity option) ATM S&P 500 straddle using VIX as the proxy for volatility, and hedge the delta position with ES futures DAILY

The ES futures prices will be estimated, and you will use a similar maturity to the option.

If realized volatility exceeds VIX at the end of the day, you sell a 5% OTM call and buy a 5% OTM put on that day with the same maturity of the original structure.

All options are held to maturity

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