33 lines
2.4 KiB
Plaintext
33 lines
2.4 KiB
Plaintext
814 Part VI: Measuring and Trading Volatility
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TRADING THE VOLATILITY PREDICTION
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The volatility trader must have some way of determining when implied volatility is
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sufficiently out of line that it warrants a trade. Then he must decide what trade to
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establish. Furthermore, as with any strategy- especially option strategies - follow-up
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action is important too. We will not be introducing any new strategies, per se, in this
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chapter. Those strategies have already been laid out in the previous chapters of this
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book. However, we will briefly review important points about those strategies and
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their follow-up actions where it is appropriate.
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First, one must try to find situations in which implied volatility is out of line.
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That is not the end of the analysis, though. After that, one needs to do some proba
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bility work and needs to see how the underlying has behaved in the past. Other fine
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tuning measures are often useful, too. These will all be described in this chapter.
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DETERMINING WHEN VOLATILITY IS OUT OF LINE
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There is much disagreement among volatility traders regarding the best method to use
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for determining if implied volatility is "out ofline." Most favor comparing implied with
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historical volatility. However, it was shown two chapters ago that implied volatility is
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not necessarily a good predictor of historical volatility. Yet this approach cannot be dis
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carded; however it must be used judiciously. Another approach is to compare today's
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implied volatility with where it has been in the past. This concept relies heavily on the
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concept of the percentile of implied volatility. Finally, there is the approach of trying
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to "read" the charts of implied and historical volatility. This is actually something akin
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to what GARCH tries to do, but on a short-term horizon. So the approaches are:
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1. Compare implied volatility to its own past levels (percentile approach).
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2. Compare implied volatility to historical volatility.
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3. Interpret the chart of volatility.
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In addition, we will examine two lesser-used methods: comparing current levels of
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historical volatility to past measures of historical volatility, and finally, using only a
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probability calculator and trading the situation that has the best probabilities of
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success.
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THE PERCENTILE APPROACH
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In this author's opinion, there is much merit in the percentile approach. When one says
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that volatility tends to trade in a range, which is the basic premise behind volatility trad- |