33 lines
2.6 KiB
Plaintext
33 lines
2.6 KiB
Plaintext
748 Part VI: Measuring and Trading Volatility
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Sellers of volatility, however, have to be a lot more careful. One mistake could
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be the last one. Selling naked calls that seem terrifically expensive by historic stan
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dards could be ruinous if a takeover bid subsequently emerges at a large premium to
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the stock's current price. Even put sellers must be careful, although a lot of traders
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think that selling naked puts is safe because it's the same as buying stock. But who
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ever said buying stock wasn't risky? If the stock literally collapses - falling from 80,
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say, to 15 or 20, as Oxford Health did, or from 30 to 2 as Sunrise Technology did -
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then a put seller will be buried. Since the risk of loss from naked option selling is
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large, one could be wiped out by a huge gap opening. That's why it's imperative to
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study why the options are expensive before one sells them. If it's known, for exam
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ple, that a small biotech company is awaiting FDA trial results in two weeks,~and all
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the options suddenly become expensive, the volatility seller should not attempt to be
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a hero. It's obvious that at least some traders believe that there is a chance for the
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stock to gap in price dramatically. It would be better to find some other situation in
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which to sell options.
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The seller of futures options or index options should be cautious too, although
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there can't be takeovers in those markets, nor can there be a huge earnings surprise
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or other corporate event that causes a big gap. The futures markets, though do have
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things like crop reports and government economic data to deal with, and those can
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create volatile situations, too. The bottom line is that volatility selling - even hedged
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volatility selling - can be taxing and aggravating if one has sold volatility in front of
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what turns out to be a news item that justifies the expensive volatility.
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SUMMARY
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Volatility trading is a predictable way to approach the market, because volatility
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almost invariably trades in a range and therefore its value can be estimated with a
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great deal more precision than can the actual prices of the underlyings. Even so, one
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must be careful in his approach to volatility trading, because diligent research is
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needed to determine if, in fact, volatility is "cheap" or "expensive." As with any sys
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tematic approach to the market, if one is sloppy about his research, he cannot expect
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to achieve superior results. In the next few chapters, a good deal of time will be spent
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to give the reader a good understanding of how volatility affects positions and how it
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can be used to construct trades with positive expected rates of return. |