Volatility premium on the capital market: risk premium for investors explained | Financial expert reveals facts and opportunities

Volatility premium on the capital market: risk premium for investors explained | Financial expert reveals facts and opportunities

Investors are paid on the capital market for taking on risks. You invest in companies by buying stocks or bonds and in return expect a return in the form of price increases or dividends. But how can investors hedge their risk? This is where the volatility premium comes into play.

Volatility premium refers to an insurance transaction in which risk-averse market participants purchase put options to hedge their stock market risks. The buyer of the put option insures his stock portfolio in a similar way to how a property owner insures his house against damage. The seller of the option assumes the buyer's risk and accepts a premium in return.

An analysis of the broad US stock market, the S&P 500, shows that the volatility premium is one of the clearly justifiable and verifiable premiums on the capital market. The options on the S&P 500 are very easy to trade and are among the most liquid in the world. In the options market, a distinction is made between implied and realized volatility. Implied volatility expresses the expected fluctuation of the stock market, while realized volatility reflects the actual fluctuation. Typically, too much risk is priced into the options, resulting in a volatility premium that is “too expensive.”

To analyze the attractiveness of the volatility premium, we look at the historical development of put options on the S&P 500. Over the last ten years, a put option with a term of two months has cost on average over 2.2 times more than justified by the realized volatility. This shows that a risk premium can be earned for selling put options.

However, it is important to note that there are always “damages” in the capital market in which the seller of the options can lose money. Therefore, professional and experienced management is necessary to make the volatility premium attractive in the long term.

Overall, the volatility premium is a clearly justifiable and verifiable premium on the capital market. Investors can benefit by selling put options and retaining the premium. However, it is important to understand the risks and have professional management to limit possible losses.

According to a report by www.dasinvestment.com,