Equity Portfolio Trading with Volatility and Dividend Derivatives

Abstract

In this article, I investigate trading strategies for equity portfolio analysis that considers diversification using dividend derivatives. The equity portfolio is assumed to be perfectly or highly correlated with the Euro STOXX 50® Index. The strategy employing dividend derivatives for hedging is compared with the more common strategy based on using VSTOXX® derivatives. I highlight that hedging with dividend derivatives offers a viable and possibly superior long-term alternative for hedging equity portfolios with stock index derivatives. In addition, I show that ATM volatility options could have been used successfully to hedge equity tail risk associated with the Brexit event in 2016 that caused a 9% drop in the Euro STOXX 50 immediately after the vote.