Delta-Neutral Volatility Trading with Intra-Day Prices: An Application to Options on the DAX

This paper evaluates the profitability of applying four different volatility forecastingmodels to the trading of straddles on the German stock market index DAX. Special carehas been taken to use simultaneous intra-day prices and realistic transaction costs.Furthermore, straddle positions were evaluated on a daily basis to preserve deltaneutrality. The four models applied in this paper are: historical volatility, two ARCH models,and an autoregressive model for the volatility index VDAX. The ARCH models perform bestin generating profits for market makers. Forecasts based on historical volatility alsoproduce statistically and economically significant profits over the two-year simulationperiod of 1993 and 1994. In general, a filter rule with a small filter of 0.5 per centproduces the best result for both the ARCH and historical volatility. However, the VDAX-ARmodel generates much lower usually unsignificant profits, and for some filter rulesthis model even has cumulative losses for market makers. For non-profit-makers and non-membersof exchange, however, larger transaction costs imply that no significant profits can begained with any model of volatility forecasts.

Schmitt, Christian and J. Kähler (1996), Delta-Neutral Volatility Trading with Intra-Day Prices: An Application to Options on the DAX, ZEW Discussion Paper No. 96-25, Mannheim.