36 lines
2.6 KiB
Plaintext
36 lines
2.6 KiB
Plaintext
Chapter 37: How Volatility Affects Popular Strategies 765
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So now one has the idea of how the excess value is affected by the "big three"
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of stock price movement, change in implied volatility, and passage of time. How can
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one use this to his advantage? First of all, one can see that an option's excess value
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may be due much more to the potential volatility of the underlying stock, and there
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fore to the option's implied volatility, than to time.
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As a result of the above information regarding excess value, one shouldn't think
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that he can easily go around selling what appear to be options with a lot of excess
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value and then expect time to bring in the profits for him. In fact, there may be a lot
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of volatility both actual and implied - keeping that excess value nearly intact for a
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fairly long period of time. In fact, in the coming chapters on volatility estimation, it
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will be shown that option buyers have a much better chance of success than conven
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tional wisdom has maintained.
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VOLATILITY AND THE PUT OPTION
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While it is obvious that an increase in implied volatility ½ill increase the price of a put
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option, much as was shown for a call option in. the preceding discussion, there are
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certain differences between a put and a call, so a little review of the put option itself
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may be useful. A put option tends to lose its premium fairly quickly as it becomes an
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in-the-money option. This is due to the realities of conversion arbitrage. In a con
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version arbitrage, an arbitrageur or market-maker buys stock and buys the put, while
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selling the call. If he carries the position to expiration, he will have to pay carrying
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costs on the debit incurred to establish the position. Furthermore, he would earn any
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dividends that might be paid while he holds the position. This information was pre
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sented in a slightly different form in the chapter on arbitrage, but it is recounted
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here:
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In a perfect world, all option prices would be so accurate that there would be
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no profit available from a conversion. That is, the following equation (1) would apply:
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(1) Call price+ Strike price - Stock price - Put price+ Dividend- Carrying cost= 0
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where carrying cost = strike price/ (1 + r)t
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t = time to expiration
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r = interest rate
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Now, it is also known that the time value premium of a put is the amount by which
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its value exceeds intrinsic value. The intrinsic value of an in-the-money put option is
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merely the difference between the strike price and the stock price. Hence, one can
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write the following equation (2) for the time value premium (TVP) of an in-the
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money put option: |