30 lines
2.0 KiB
Plaintext
30 lines
2.0 KiB
Plaintext
Trading Implied Volatility
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With a typical option, the sensitivity of delta overshadows that of vega. To
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try and profit from a rise or fall in IV, one has to trade delta neutral to
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eliminate immediate directional sensitivity. There are many strategies that
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can be traded as delta-neutral IV strategies simply by adding stock.
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Throughout this chapter, I will continue using a single option leg with
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stock, since it provides a simple yet practical example. It’s important to note
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that delta-neutral trading does not refer to a specific strategy; it refers to the
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fact that the trader is indifferent to direction. Direction isn’t being traded,
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volatility is.
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Volatility trading is fundamentally different from other types of trading.
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While stocks can rise to infinity or decline to zero, volatility can’t. Implied
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volatility, in some situations, can rise to lofty levels of 100, 200, or even
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higher. But in the long-run, these high levels are not sustainable for most
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stocks. Furthermore, an IV of zero means that the options have no extrinsic
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value at all. Now that we have established that the thresholds of volatility
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are not as high as infinity and not as low as zero, where exactly are they?
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The limits to how high or low IV can go are not lines in the sand. They are
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more like tides that ebb and flow, but normally come up only so far onto the
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beach.
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The volatility of an individual stock tends to trade within a range that can
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be unique to that particular stock. This can be observed by studying a chart
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of recent volatility. When IV deviates from the range, it is typical for it to
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return to the range. This is called reversion to the mean , which was
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discussed in Chapter 3. IV can get stretched in either direction like a rubber
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band but then tends to snap back to its original shape.
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There are many examples of situations where reversion to the mean enters
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into trading. In some, volatility temporarily dips below the typical range,
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and in some, it rises beyond the recent range. One of the most common
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examples is the rush and the crush. |