36 lines
2.7 KiB
Plaintext
36 lines
2.7 KiB
Plaintext
836 Part VI: Measuring and Trading Volatility
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you do both, though, you create a "good news, bad news" situation. The good news
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is that the maximum risk is reduced; for example, if XYZ goes exactly to 130 (the
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worst point for the call spread), the companion put spread's credit would reduce that
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risk a little. However, the bad news is that there is a much wider range over which
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there is not profit, since there are two spots where losses are more or less maximized
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(at the strike price of the long calls and again at the strike price of the long puts).
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Margin will be discussed only briefly, since it was addressed in the chapter on
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reverse spreads. For both index and stock options, this strategy is considered to have
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naked options - a preposterous assumption, since one can see from the profit graph
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that the position is fully hedged until the near-term options expire. This raises the
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capital requirement for nonmember traders. The margin anomaly is not a problem
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with futures options, however. For those options, one need only margin the differ
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ence in the strikes, less any credit received, because that is the true risk of the posi
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tion. In summary, the volatility trader who wants to sell volatility in equity and futures
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options markets needs to be hedged, because gaps are prevalent and potentially very
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costly. This strategy creates a more neutral, less price-dependent way to benefit if
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implied volatility decreases, especially when compared with simple credit spreads.
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SUMMARY: TRADING THE
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VOLATILITY PREDICTION
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Attempting to establish trades when implied volatility is out of line is a theoretically
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attractive strategy. The process outlined above consisted of a few steps, employing
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both statistical and theoretical analysis. In any case, though, probability calculators
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must "say" that a volatility trade has good probabilities of success. It's merely a mat
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ter of what criteria we apply to limit our choices before we run the probability analy
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sis. So, it might be more useful to view volatility trading analysis in this light:
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Step I: Use a selection criterion to limit the myriad of volatility trading choices. Any
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of these could be used as the first criterion, but not all of them at once:
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a. Require implied volatility to be at an extreme percentile.
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b. Require historical and implied volatility to have a large discrepancy
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between them.
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c. Interpret the chart of implied volatility to see if it has reversed trend.
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Step 2: Use a probability calculator to project whether the strategy can be expected
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to be a success.
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Step 3: Using past price histories, determine whether the underlying has been able
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to create profitable trades in the past. (For example, if one is considering |