48 lines
2.5 KiB
Plaintext
48 lines
2.5 KiB
Plaintext
760 Part VI: Measuring and Trading Volatility
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Finally, to be able to completely compare this example with the previous one, it
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is necessary to see what implied volatility would have to rise to in order to offset the
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effect of yet another month's time decay. It turns out to be over 140%:
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Stock Price:
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Strike Price:
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Time Remaining:
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Implied Volatility:
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Theoretical Call Value:
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100
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100
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1 month
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140.9%
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16.45
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Table 37-4 summarizes the results of these examples, showing the levels to
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which implied volatility would have to rise to maintain the call's value as time passes.
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Are the volatility increases in the latter example less likely to occur than the
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ones in the former example? Probably yes - certainly the last one, in which implied
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volatility would have to increase from 80% to nearly 141 % in order to maintain the
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call's value. However, in another sense, it may seem more reasonable: Note that the
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increase in volatility from 20% to 26% is a 30% increase. That is, 20% times 1.30
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equals 26%. That's what's required to maintain the call's value for the lower volatility
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over the first month - an increase in the magnitude of implied volatility of 30%. At
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the higher volatility, though, an increase in magnitude of only about 25% is required
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(from 80% to 99%). Thus, in those terms, the two appear on more equal footing.
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What makes the top line of Table 37-4 appear more likely than the bottom line
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is merely the fact that an experienced option trader knows that many stocks have
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implied volatilities that can fluctuate in the 20% to 40% range quite easily. However,
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there are far fewer stocks that have implied volatilities in the higher range. In fact,
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until the Internet stocks got hot in the latter portion of the 1990s, the only ones with
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volatilities like those were very low-priced, extremely volatile stocks. Hence one's
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experience factor is lower with such high implied volatility stocks, but it doesn't mean
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that the volatility fluctuations appearing in Table 37-4 are impossible.
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If the reader has access to a software program containing the Black-Scholes
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model, he can experiment with other situations to see how powerful the effect of
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implied volatility is. For example, without going into as much detail, if one takes the
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case of a 12-month option whose initial implied volatility is 20%, all it takes to main-
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TABLE 37-4
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Initial Implied
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Volatility
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20%
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80%
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Volatility Leveled Required to Maintain Call Value ...
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... After One Month ... After Two Months
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26%
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99%
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38%
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141% |