Source Link: https://archive.ph/Q7x7Q "The sweet spot, where the annualized return from the trade is optimal, is around 25%. One might expect the 50% exposure to have the highest return. This is true for yield, but not true in terms of compounded annual return. The reason is simple: a 50% drawdown requires a 100% return to get back to even. So even though the yield at 50% exposure is two times the yield for the 25% exposure product, the extra yield is more than offset by the larger drawdowns. Investors looking to capture the volatility premium over extended periods should therefore focus on the “compound optimal” exposure near 25%, rather than the “yield maximizing” exposure near 50%. In the previous section, we saw that reducing drawdowns is critical to optimal harvesting of the volatility risk premium. Beyond tuning the total exposure of the trade, we can also consider the direct use of options to help limit downside and improve compound returns. Figure 3 shows the cumulative performance during the March 2020 crisis of a simple hypothetical strategy that is -25% short VIX and rolls a monthly call option on VXX that is 200% out-of-the-money, spending 1% annually on option premium (1/12th of 1% each month). Also in Figure 3, we see the performance of the -25% VIX strategy without options. The March 2020 drawdown gets cut in half from the option position, and even at the relatively small 1% annual option budget, we see the options add significant value to the strategy beyond just drawdown protection." Video created with https://ttsmp3.com/ & https://www.onlineconverter.com/audio-to-video