37 lines
2.7 KiB
Plaintext
37 lines
2.7 KiB
Plaintext
744 Part VI: Measuring and Trading Volatility
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ity has been selling it (or at least, when the majority is refusing to buy it), and he will
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be selling volatility when everyone else is panicking to buy options, making them
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quite expensive.
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WHY DOES VOLATILITY REACH EXTREMES?
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One can't just buy every option that he considers to be cheap. There must be some
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consideration given to what the probabilities of stock movement are. Even more
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important, one can't just sell every option that he values as expensive. There may be
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valid reasons why options become expensive, not the least of which is that someone
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may have inside information about some forthcoming corporate news (a takeover or
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an earnings surprise, for example).
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Since options off er a good deal of leverage, they are an attractive vehicle to any
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one who wants to make a quick trade, especially if that person believes he knows
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something that the general public doesn't know. Thus, if there is a leak of a takeover
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rumor - whether it be from corporate officers, investment bankers, printers, or
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accountants - whoever possesses that information may quite likely buy options
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aggressively, or at least bid for them. Whenever demand for an option outstrips sup
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ply - in this case, the major supplier is probably the market-maker - the options
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quickly get more expensive. That is, implied volatility increases.
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In fact, there are financial analysts and reporters who look for large increases in
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trading volume as a clue to which stocks might be ready to make a big move.
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Invariably, if the trading volume has increased and if implied volatility has increased
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as well, it is a good warning sign that someone with inside information is buying the
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options. In such a case, it might not be a good idea to sell volatility, even though the
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options are mathematically expensive.
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Sometimes, even more minor news items are known in advance by a small seg
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ment of the investing community. If those items will be enough to move the stock
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even a couple of points, those who possess the information may try to buy options in
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advance of the news. Such minor news items might include the resignation or firing
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of a high-ranking corporate officer, or perhaps some strategic alliance with another
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company, or even a new product announcement.
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The seller of volatility can watch for two things as warning signs that perhaps
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the options are "predicting" a corporate event (and hence should be avoided as a
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"volatility sale"). Those two things are a dramatic increase in option volume or a sud
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den jump in implied volatility of the options. One or both can be caused by traders
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with inside information trying to obtain a leveraged instrument in advance of the
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actual corporate news item being made public. |