30 lines
2.2 KiB
Plaintext
30 lines
2.2 KiB
Plaintext
CHAPTER 36
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The Basics of
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Volatility Trading
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Volatility trading first attracted mathematically oriented traders who noticed that the
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market's prediction of forthcoming volatility - for example, implied volatility - was
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substantially out of line with what one might reasonably expect should happen.
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Moreover, many of these traders (market-makers, arbitrageurs, and others) had
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found great difficulties with keeping a "delta neutral" position neutral. Seeking a bet
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ter way to trade without having a market opinion on the underlying security, they
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turned to volatility trading. This is not to suggest that volatility trading eliminates all
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market risk, turning it all into volatility risk, for example. But it does suggest that a
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certain segment of the option trading population can handle the risk of volatility with
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more deference and aplomb than they can handle price risk
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Simply stated, it seems like a much easier task to predict volatility than to pre
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dict prices. That is said notwithstanding the great bull market of the 1990s, in which
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every investor who strongly participated certainly feels that he understands how to
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predict prices. Remember not to confuse brains with a bull market. Consider the chart
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in Figure 36-1. This seems as if it might be a good stock to trade: Buy it near the lows
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and sell it near the highs, perhaps even selling it short near the highs and covering
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when it later declines. It appears to have been in a trading range for a long time, so
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that after each purchase or sale, it returns at least to the midpoint of its trading range
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and sometimes even continues on to the other side of the range. There is no scale on
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the chart, but that doesn't change the fact that it appears to be a tradable entity. In
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fact, this is a chart of implied volatility of the options on a major U.S. corporation. It
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really doesn't matter which one (it's IBM), because the implied volatility chart of near
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ly every stock, index, or futures contract has a similar pattern - a trading range. The
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only time that implied volatility will totally break out of its "normal" range is if some
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thing material happens to change the fundamentals of the way the stock moves - a
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takeover bid, for example, or perhaps a major acquisition or other dilution of the stock
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