40 lines
3.1 KiB
Plaintext
40 lines
3.1 KiB
Plaintext
788 Part VI: Measuring and Trading VolatiDty
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ally including gap moves. There are not always gap moves, though, over a study of
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this length. Sometimes, there will be a more gradual transition. Consider the fact that
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one of the stocks in the study moved 5.8 sigma in the 30 days. There weren't any huge
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gaps during that time, but anyone who was short calls while the stock made its run
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surely didn't think it was a gradual advance.
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So, what does this information mean to the average option trader? For one,
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you should certainly think twice about selling stock options in a potentially volatile
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market ( or any market, for that matter, since these large moves are not by any means
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limited to the volatile market periods). This statement encompasses naked option
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selling, but also includes many forms of option selling, because of the possibilities of
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large moves by the underlying stocks.
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For example, covered call writing is considered to be "conservative." However,
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when the stock has the potential to make these big moves, it will either cause one to
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give up large upside profits or to suffer large downside losses. ( Covered call writing
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has limited profit potential and relatively large downside risk, as does its equivalent
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strategy, naked put selling.) When these large stock moves occur on the upside, a cov
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ered writer is often disappointed that he gave up too much of the upside profit poten
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tial. Conversely, if the stock drops quickly, and one is assigned on his naked put, he
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often no longer has much appetite for acquiring the stock ( even though he said he
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"wouldn't mind" doing so when he sold the puts to begin with).
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Even spreading has problems along these lines. For example, a vertical spread
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limits profits so that one can't participate in these relatively frequent large stock
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moves when they occur.
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What can an option seller do? First, he must carefully analyze his position and
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allow for much larger stock movements than one would expect under the lognormal
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distribution. Also, he must be careful to sell options only when they are expensive in
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terms of implied volatility, so that any decrease in implied will work in his favor.
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Probably most judicious, though, is that an option seller should really concentrate on
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indices (or perhaps certain futures contracts), because they are statistically much less
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volatile than stocks. Hard as it is to believe, futures are less volatile than stocks
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(although the leverage available in futures can make them a riskier investment overall).
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Two 30-day studies, similar to those conducted on stocks, were run on option
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able indices, covering the same time periods: 10/22/99 to 12/7/99 for one study and
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7/1/93 to 8/17/93 for the other. The results are shown in Tables 38-5 and 38-6. This
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may be a somewhat distorted picture, though, because many of these indices overlap
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(there are four Internet indices, for example). The largest mover was the Morgan
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Stanley High-Tech Index (5 standard deviations), but it should also be noted that
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something that is considered fairly tame, such as the Russell 2000 ($RUT), also had
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a 3-standard deviation move in one study. The first study showed that 37% of the |