36 lines
2.3 KiB
Plaintext
36 lines
2.3 KiB
Plaintext
840 Part VI: Measuring and Trading Volatility
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The causes of this effect stem from the stock market's penchant to crash occa
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sionally. Investors who want protection buy index puts; they don't sell index futures
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as much as they used to because of the failure of the portfolio insurance strategy dur
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ing the 1987 crash. In addition, margin requirements for selling naked index puts
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have increased, especially for market-makers, who are the main suppliers of naked
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puts. Consequently, demand for index puts is high and supply is low. Therefore, out
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of-the-money index puts are overly expensive.
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This does not entirely explain why index calls are so cheap. Part of the reason
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for that is that institutional traders can help finance the cost of those expensive index
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puts by selling some out-of-the-money index calls. Such sales would essentially be
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covered calls if the institution owned stocks, which it most certainly would. This strat
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egy is called a collar.
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This distortion in volatilities is not in accordance with the probability distribu
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tion of stock prices. These distorted implied volatilities define a different probability
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curve for stock movement. They seem to say that there is more chance of the market
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dropping than there is of it rising. This is not true; in fact, just the opposite is true.
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Refer to the reasons for using lognormal distribution to define stock price move
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ments. Consequently, there are opportunities to profit from volatility skewing, if one
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is able to hold the position until expiration.
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It was shown in previous examples that one would attempt to sell the options
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with higher implied volatilities and buy ones with lower implieds as a hedge. Hence,
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for OEX traders, three strategies seem relevant:
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1. Buy a bear put spread in OEX.
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Example: Buy 10 OEX June 560 puts
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Sell IO OEX June 540 puts
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2. Buy OEX puts and sell a larger number of out-of-the-money puts - a ratio write
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of put options.
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Example: Buy 10 OEX June 560 puts
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Sell 20 OEX June 550 puts
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3. Sell OEX calls and buy a larger number of out-of-the-money calls - a backspread
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of call options.
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Example: Buy 20 OEX June 590 calls
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Sell IO OEX June 580 calls
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In all three cases, one is selling the higher implied volatility and buying options
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with lower implied volatilities. The first strategy is a simple bear spread. While it will |