I have found a hedging strategy that always makes money. Obviously I am not going to tell you what it is but I wondered if anyone else on here had spotted it. I'll give you a hint: if you integrate the static option replication over time and calculate the moment generating function for the driving stochastic process (I use stochastic local volatility with jump diffusion - the calculation is too technical to go into detail here) then it is a simple matter of equating the coefficients.

great, but I know a replicating portfolio that always matches the variance swaps payoff

I wonder what that portfolio might be... wow really rocket science here!

QuoteOriginally posted by: worowgreat, but I know a replicating portfolio that always matches the variance swaps payoffEveryone knows about the replicating portfolio; I am talking about the next level: not only does it replicate the payoff but it always makes a profit, even if you sell at fair value.

QuoteOriginally posted by: ABunchOfQuantsQuoteOriginally posted by: worowgreat, but I know a replicating portfolio that always matches the variance swaps payoffEveryone knows about the replicating portfolio; I am talking about the next level: not only does it replicate the payoff but it always makes a profit, even if you sell at fair value.wow! have you also found the trick for perpetual motion?

QuoteOriginally posted by: granchioQuoteOriginally posted by: ABunchOfQuantsQuoteOriginally posted by: worowgreat, but I know a replicating portfolio that always matches the variance swaps payoffEveryone knows about the replicating portfolio; I am talking about the next level: not only does it replicate the payoff but it always makes a profit, even if you sell at fair value.wow! have you also found the trick for perpetual motion?Come on... That's impossible. Do the maths and you might understand what I am talking about.

Selling at fair value and always making a profit = selling at the arbitrage-free price and doing an arbitrage.Let's call it the Variance Swap Paradox !!

LOL!

QuoteOriginally posted by: PasargadSelling at fair value and always making a profit = selling at the arbitrage-free price and doing an arbitrage.Let's call it the Variance Swap Paradox !!Look, its not the same as a perpetual energy machine. Its easy to construct a strategy that always loses money, right (eg., I donate 50% of my profits to charity on a daily basis). The difference is that a loss making strategy for one person is a money making strategy for someone else so all I have to do is take my money losing strategy and change the signs. As far as I am aware there is no law of conservation of money, unlike the case of energy. Anyway, I don't know why I'm trying to convince you - its all the more money for me. I just wanted to know if anyone else was working on the same thing.

Look, what is funny here is the wording... basically, if by selling at the fair you always make a profit, it means that is not the fair.It might (just might) be possible that you discovered that the standard approach for pricing varswaps is arbitrageable.In which case go out an trade it heavily, and move the market till it reaches the real "fair" that you have discovered

Did anybody ever bother telling this fucking muppet that there is a convexity adjustment for volatility swaps and that Sqrt(VarSwap) ain't the expected volatility? Maybe you wanna like point that out to him... actually, on second thought... don't point it out to him.

QuoteOriginally posted by: KharnakDid anybody ever bother telling this fucking muppet that there is a convexity adjustment for volatility swaps and that Sqrt(VarSwap) ain't the expected volatility? Maybe you wanna like point that out to him... actually, on second thought... don't point it out to him.There's no need to call me a "fucking muppet". What are you on about convexity adjustments for? You should read the thread first before jumping on it! We are talking about VARIANCE SWAPS not VOLATILITY SWAPS. Any fucking muppet knows that a variance swap has a static replicating portfolio.

I did read the thread, you fucking muppet, and I'm fairly certain that your "moment generating function for the driving stochastic process" is in reality nothing more than:Or something similar depending on your processwhich you expect to bag for free... I suggest you let Pat give you a bit of summer schooling.Anyway, anyone that puts a Ferrari Enzo as his icon can't be helped anyway.Later.

QuoteOriginally posted by: KharnakI did read the thread, you fucking muppet, and I'm fairly certain that your "moment generating function for the driving stochastic process" is in reality nothing more than:Or something similar depending on your processwhich you expect to bag for free... I suggest you let Pat give you a bit of summer schooling.Anyway, anyone that puts a Ferrari Enzo as his icon can't be helped anyway.Later.Is there anything against having a picture of your car as an icon? I'm impressed you were able to identify it. I suppose you drive a Ferrari Gonzo you muppet.The moment generating function is a tad more complicated than the formula you have presented. I appreciate the offer for more schooling but I think my PhD in quantum field theory from Cambridge should be sufficient for most problems that crop up in the field of finance.If you don't have anything constructive to say why bother saying it?

Actually, that's the final solution, solving for your "free" lucnh. As you said, the "the calculation is too technical to go into detail here". So in that spirit I chose not to go through the additional four lines to derive it, however, should you require it, I can certainly do so (although I'm sure as a Quantum Field Theory specialist that won't be necessary). As I said, that would be what you are probably expecting to bag. Am I correct? Of course the final result could be something more or less complex, depending on your stochastic drivers, but hey, I'm sure you figured that out (no... wait, apparently you didn't)Speaking of anything constructive to say... like you need to talk... Kind Regards,The Muppet Master