38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
818 Part VI: Measuring and Trading Volatility
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quickly revert back to where they were. But for a position trader, the problems cited
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above can be troublesome.
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Having said that, if one looks to implement this method of trying to determine
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when options are out of line, something along the following lines should be imple
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mented. One should ensure that implied volatility is significantly different from all of
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the pertinent historical volatilities. For example, one might require that implied
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volatility is less than 80% of each of the 10-, 20-, 50-, and 100-day historical volatili
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ty calculations. In addition, the current percentile of implied volatility should be
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noted so that one has some relative basis for determining if all of the volatilities, his
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torical and implied, are very high or very low. One would not want to buy options if
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they were all in a very high percentile, nor sell them if they were all in a very low per
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centile.
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Often, a volatility chart showing both the implied and certain historical volatili
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ties will be a useful aid in making these decisions. One can not only quickly tell if the
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options are in a high or low percentile, but he may also be able to see what happened
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at similar times in the past when implied and historical volatility deviated substan
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tially.
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Finally, one needs some measure to ensure that, if convergence between
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implied and historical volatility does occur, he will be able to make money. So, for
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example, if one is buying a straddle, he might require that if implied rises to meet his
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torical (say, the lowest of the historicals) in a month, he will actually make money.
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One could use a different time frame, but be careful not to make it something unrea
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sonable. For example, if implied volatility is currently 40% and historical is 60%, it is
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highly unlikely that implied would rise to 60% in a day or two. Using this criterion
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also ensures that the absolute difference between implied and historical volatility is
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wide enough to allow for profits to be made. That is, if implied is 10% and historical
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is 13%, that's a difference of 30% in the two - ostensibly a "wide" divergence
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between implied and historical. However, if implied rises to meet historical, it will
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mean only an absolute increase of 3 percentage points in implied volatility - proba
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bly not enough to produce a profit, after costs, if any length of time passes.
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If all of these criteria are satisfied, then one has successfully found "mispriced"
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options using the implied versus historical method, and he can proceed to the next
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step in the volatility analysis: using the probability calculator.
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READING THE VOLATILITY CHART
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Another technique that traders use in order to determine if options are mispriced is
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to actually try to analyze the chart of volatility - typically implied volatility, but it
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could be historical. This might seem to be a subjective approach, except that it is real- |