34 lines
2.2 KiB
Plaintext
34 lines
2.2 KiB
Plaintext
to its value increase? Was it delta because the underlying stock rose? Or
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was it vega because volatility rose? How did time decay factor in? Using a
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volatility chart in conjunction with a conventional stock chart (and being
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aware of time decay) tells the whole, complete, story.
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Another reason historical option prices are not used in TA is the option
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bid-ask spread. For most stocks, the difference between the bid and the ask
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is equal to a very small percentage of the stock’s price. Because options are
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highly leveraged instruments, their bid-ask width can equal a much higher
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percentage of the price.
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If a trader uses the last trade to graph an option’s price, it could look as if
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a very large percentage move has occurred when in fact it has not. For
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example, if the option trades a small contract size on the bid (0.80), then on
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the offer (0.90) it would appear that the option rose 12.5 percent in value.
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This large percentage move is nothing more than market noise. Using
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volatility data based off the midpoint-of-the-market theoretical value
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eliminates such noise.
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Fundamental Analysis
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Fundamental analysis can have an important role in developing
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expectations for IV. Fundamental analysis is the study of economic factors
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that affect the value of an asset in order to determine what it is worth. With
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stocks, fundamental analysis may include studying income statements,
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balance sheets, and earnings reports. When the asset being studied is IV,
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there are fewer hard facts available. This is where the art of analyzing
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volatility comes into play.
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Essentially, the goal is to understand the psychology of the market in
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relation to supply and demand for options. Where is the fear? Where is the
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complacency? When are news events anticipated? How important are they?
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Ultimately, the question becomes: what is the potential for movement in the
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underlying? The greater the chance of stock movement, the more likely it is
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that IV will rise. When unexpected news is announced, IV can rise quickly.
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The determination of the fundamental relevance of surprise announcements
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must be made quickly.
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Unfortunately, these questions are subjective in nature. They require the
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trader to apply intuition and experience on a case-by-case basis. But there |