37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
830 Part VI: Measuring and Trading Volatility
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Example: A trader is considering the purchase of the XYZ October 40 straddle for
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11 points, with the stock at 39.60. The options are cheap and the probabilities of suc
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cess appear to be good, according to the probability calculator. The question that now
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needs to be asked and answered is this: "In the past, has this stock been able to move
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11 points in 10 months (the time remaining in the straddle's life)?" Or, more impor
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tantly, since 11 divided by 39.60 is about 28%, "Has this stock been able to make
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moves of 28% over 10 months, in the past?" The answers to these questions can be
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readily obtained if stock price history data is available. One could even look at a chart
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of the stock and attempt to answer the questions himself without the aid of a com
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puter, but computer analysis of the price history is more rigorous and is therefore
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encouraged.
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The answers can be expressed in the form of probabilities, much as the results
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of the probability calculator are.
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Suppose one determines that the stock has been able to move 11 points in 10
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months 77% of the time in the past. That's okay, but not great. However, when one
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looks at the price chart ofXYZ, he sees that it traded at much lower prices - near $10
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a share - for a long time before rising to its current levels. It would be very hard to
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expect a $10 stock to move 11 points in 10 months. That's why the second figure, the
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one involving the 28% move, is the more significant one. In this case, one might find
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that XYZ has been able to move 28% in 10 months over 90% of the time in the past.
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Now one has what appears to be a decent-looking straddle buy.
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This analysis of past prices can be done in a more sophisticated manner. Rather than
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just asking whether or not the stock has moved the required distance in the past, one
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might want to see just how the stock's movements "look." That is, there are a couple
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of scenarios under which the past movements might look attractive, but upon closer
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examination, one would not be so sanguine.
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For example, what ifXYZ had repeatedly moved 28%, but never much more in
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most of the IO-month periods that comprise its stock history? Then, one would be
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less inclined to want to own this straddle.
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Another scenario of past movements might be that XYZ had made moves that
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one could not reasonably expect to be repeated. Perhaps there was a huge gap down
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on an earnings shortfall, or if it was an Internet stock around the tum of the millen
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nium, it had a huge move upward, followed by a huge move downward. That would
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be another nonrepeating type of move, because absent the Internet mania, the stock
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might have been a rather range-bound item both prior to and after the one huge,
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round-trip move. |