38 lines
2.9 KiB
Plaintext
38 lines
2.9 KiB
Plaintext
Chapter 36: The Basics of Volatility Trading 743
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prediction that is somewhat "middle of the road," since an extreme prediction is
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more likely to be wrong. Of course, it turns out to be wrong anyway, since actual
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volatility jumps around quite rapidly.
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The few charts that have been presented here don't constitute a rigorous study
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upon which to draw the conclusion that implied volatility is a poor predictor of actu
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al volatility, but it is this author's firm opinion that that statement is true. A graduate
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student looking for a master's thesis topic could take it from here.
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VOLATILITY TRADING
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As a result of the fact that implied volatility can sometimes be at irrational extremes,
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options may sometimes trade with implied volatilities that are significantly out of line
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with what one would normally expect. For example, suppose a stock is in a relatively
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nonvolatile period, like the price of the stock in Figure 36-2, just before point A on
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the graph. During that time, option sellers would probably become more aggressive
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while option buyers, who probably have been seeing their previous purchases decay
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ing with time, become more timid. As a result, option prices drop. Alternatively stat
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ed, implied volatility drops. When implied volatilities are decreasing, option sellers
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are generally happy (and may often become more aggressive), while option buyers
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are losing money (and may often tend to become more timid). This is just a function
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of looking at the profit and loss statements in one's option account. But anyone who
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took a longer backward look at the volatility of the stock in Figure 36-2 would see that
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it had been much more volatile in the past. Consequently, he might decide that the
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implied volatility of the options had gotten too low and he would be a buyer of
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options.
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It is the volatility trader's objective to spot situations when implied volatility is
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possibly or probably erroneous and to take a position that would profit when the
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error is brought to light. Thus, the volatility trader's main objective is spotting situa
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tions when implied volatility is overvalued or undervalued, irrespective of his outlook
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for the underlying stock itself. In some ways, this is not so different from the funda
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mental stock analyst who is attempting to spot overvalued or undervalued stocks,
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based on earnings and other fundamentals.
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From another viewpoint, volatility trading is also a contrarian theory of invest
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ing. That is, when everyone else thinks the underlying is going to be nonvolatile, the
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volatility trader buys volatility. When everyone else is selling options and option buy
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ers are hard to find, the volatility trader steps up to buy options. Of course, some rig
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orous analysis must be done before the volatility trader can establish new positions,
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but when those situations come to light, it is most likely that he is taking positions
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opposite to what "the masses" are doing. He will be buying volatility when the major- |