Volatility Risk Premium and Financial Distress
The volatility risk premium (VRP), also known as the insurance risk premium (IRP), has become attractive to investors as a potential source to enhance portfolio returns. The VRP is generally indicated as the difference between the implied volatility of options contracts for a given security and the subsequently realized volatility of the underlying asset. The VRP may be viewed as the premium that option sellers receive from option buyers seeking a form of financial insurance. When properly constructed, a strategy of selling options to capture the VRP can generate returns with a low correlation with more traditional assets, such as equities or fixed income, add diversification benefits, and potentially enhance portfolio returns for investors.