38 lines
3.0 KiB
Plaintext
38 lines
3.0 KiB
Plaintext
Chapter 31,: 1be Basics of Volatility Trading 747
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implied volatility is high. Given that fact, he can then construct positions around a
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neutral strategy or around his view of the future. The time when the volatility seller
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must be careful is when the options are expensive and no one seems to know why.
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That's when insider trading may be present, and that's when the volatility seller
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should defer from selling options.
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CHEAP OPTIONS
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When options are cheap, there are usually far less discernible reasons why they have
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become cheap. An obvious one may be that the corporate structure of the company
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has changed; perhaps it is being taken over, or perhaps the company· has acquired
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another company nearly its size. In either case, it is possible that the combined enti
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ty's stock will be less volatile than the original company's stock was. As the takeover
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is in the process of being consummated, the implied volatility of the company's
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options will drop, giving the false impression that they are cheap.
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In a similar vein, a company may mature, perhaps issuing more shares of stock,
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or perhaps building such a.., good earnings stream that the stock is considered less
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volatile than it formerly was. Some of the Internet companies will be classic cases: In
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the beginning they were high-flying stocks with plenty of price movement, so the
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options traded with a relatively high degree of implied volatility. However, as the com
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pany matures, it buys other Internet companies and then perhaps even merges with a
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large, established company (America Online and Time-Warner Communications, for
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example). In these cases, actual (statistical) volatility will diminish as the company
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matures, and implied volatility will do the same. On the surface, a buyer of volatility
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may see the reduced volatility as an attractive buying situation, but upon further
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inspection he may find that it is justified. If the decrease in implied volatility seems
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justified, a buyer of volatility should ignore it and look for other opportunities.
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All volatility traders should be suspicious when volatility seems to be extreme -
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either too expensive or too cheap. The trader should investigate the possibilities as to
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why volatility is trading at such extreme levels. In some cases, the supply and demand
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of the public just pushes the options to extreme levels; there is nothing more involved
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than that. Those are the best volatility trading situations. However, if there is a hint
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that the volatility has gotten to an extreme reading because of some logical (but per
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haps nonpublic) reason, then the volatility trader should be suspicious and should
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probably avoid the trade. Typically this happens with expensive options.
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Buyers of volatility really have little to fear if they miscalculate and thus buy an
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option that appears inexpensive but turns out not to be, in reality. The volatility buyer
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might lose money if he does this, and overpaying for options constantly will lead to
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ruin, but an occasional mistake will probably not be fatal. |