39 lines
3.1 KiB
Plaintext
39 lines
3.1 KiB
Plaintext
Chapter 39: Volatility Trading Techniques 841
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benefit from the fact that the options are skewed in terms of implied volatility, it is not
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a neutral strategy. It requires that the underlying drop in price in order to become
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profitable. There is nothing wrong with using a directional strategy like this, but the
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strategist must be aware that the skew is unlikely to disappear ( until expiration) and
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therefore the index price movement is going to be necessary for profitability.
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The second strategy would be best suited for moderately bearish investors,
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although a severe market decline might drive the index so low that the additional
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short puts could cause severe losses. However, statistically this is an attractive strat
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egy. At expiration, the volatility skewing must disappear; the markets will have moved
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in line with their real probability distribution, not the false one being implied by the
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skewed options. This makes for a potentially profitable situation for the strategist.
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The backspread strategy would work best for bullish investors, although some
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backspreads can be created for credits, so a little money could also be made if the
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index fell. In theory, a strategist could implement both strategies simultaneously,
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which would give him an edge over a wide range of index prices. Again, this does not
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mean that he cannot lose money; it merely means that his strategy is statistically
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superior because of the way the options are priced. That is, the odds are in his favor.
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In reality, though, a neutral trader would choose either the ratio spread or the
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backspread - not both. As a general rule of thumb, one would use the ratio spread
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strategy if the current level of implied volatility were in a high percentile. The back
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spread strategy would be used if implied volatility were in a low percentile current
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ly. In that way, a movement of implied volatility back toward the 50th percentile
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would also benefit the trade that is in place.
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Another interesting thing happens in these strategies that may be to their ben
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efit: The volatility skewing that is present propagates itself throughout the striking
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prices as OEX moves around. It was shown in the previous section's example that one
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should probably continue to project his profits using the distorted volatilities that
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were present when he establishes a position. This is a conservative approach, but a
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correct one. In the case of these OEX spreads, it may be a benefit.
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Assuming that the skewing is present wherever OEX is trading means that the
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at-the-money strike will have 16% as its implied volatility regardless of the absolute
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price level; the skewing will then extend out from that strike. So, if OEX rises to 600,
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then the 600 strike would have a volatility of 16%; or if it fell to 560, then the 560
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puts and calls would have a volatility of 16%. Of course, 16% is just a representative
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figure; the "average" volatility of OEX can change as well. For illustrative purposes,
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it is convenient to assume that the at-the-money strike keeps a constant volatility.
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Example: Initially, a trader establishes a call backspread in OEX options in order to
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take advantage of the volatility skewing: |