Volatility risk premium
TheoryDefinition
The persistent gap between implied volatility (priced by options) and realized volatility (actual price moves). On average, implied vol exceeds realized vol by 1-3 percentage points across most underlyings.
Source of long-run profits for option sellers. The premium reflects investor demand for crash insurance + dealer compensation for tail risk + behavioral overestimation of future moves. Short-vol strategies harvest this premium until tail-risk crashes wipe out years of gains (e.g., XIV blowup Feb 2018).
Source of long-run profits for option sellers. The premium reflects investor demand for crash insurance + dealer compensation for tail risk + behavioral overestimation of future moves. Short-vol strategies harvest this premium until tail-risk crashes wipe out years of gains (e.g., XIV blowup Feb 2018).