35 lines
2.7 KiB
Plaintext
35 lines
2.7 KiB
Plaintext
Chapter 39: Volatility Trading Techniques 813
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watching the situation for those stocks that they will rarely let volatility get to the
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extremes that one would consider "too high" or "too low." Yet, with the large num
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ber of optionable stocks, futures, and indices that exist, there are always some that
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are out of line, and that's where the independent volatility trader will concentrate
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his efforts.
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Once a volatility extreme has been uncovered, there are different methods of
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trading it. Some traders - market-makers and short-term traders - are just looking
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for very fleeting trades, and expect volatility to fall back into line quickly after an
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aberrant move. Others prefer more of a position traders' approach: attempting to
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determine volatility extremes that are so far out of line with accepted norms that it
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will probably take some time to move back into line. Obviously, the trader's own sit
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uation will dictate, to a certain extent, which strategy he pursues. Things such as
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commission rates, capital requirements, and risk tolerance will determine whether
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one is more of a short-term trader or a position trader. The techniques to be
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described in this chapter apply to both methods, although the emphasis will be on
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position trading.
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TWO WAYS VOLATILITY PREDICTIONS CAN BE WRONG
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When traders determine the implied volatility of the options on any particular under
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lying instrument, they may generally be correct in their predictions; that is, implied
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volatility will actually be a fairly good estimate of forthcoming volatility. However,
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when they're wrong, they can actually be wrong in two ways: either in the outright
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prediction of volatility or in the path of their volatility predictions. Let's discuss both.
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When they're wrong about the absolute level of volatility, that merely means that
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implied volatility is either "too low" or "too high." In retrospect, one could only make
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that assessment, of course, after having seen what actual volatility turned out to be
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over the life of the option. The second way they could be wrong is by making the
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implied volatility on some of the options on a particular underlying instrument much
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cheaper or more expensive than other options on that same underlying instrument.
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This is called a volatility skew and it is usually an incorrect prediction about the way
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the underlying will perform during the life of the options.
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The rest of this chapter will be divided into two main parts, then. The first part
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will deal with volatility from the viewpoint of the absolute level of implied volatility
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being "wrong" (which we'll call "trading the volatility prediction"), and the second
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part will deal with trading the volatility skew. |