36 lines
2.4 KiB
Plaintext
36 lines
2.4 KiB
Plaintext
Chapter 37: How Volatility Affects Popular Strategies 767
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positively affect both the put and the call in a long straddle. Thus, if a straddle buyer
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is careful to buy straddles in situations in which implied volatility is "low," he can
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make money in one of two ways. Either (1) the underlying price makes a move great
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enough in magnitude to exceed the initial cost of the straddle, or (2) implied volatil
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ity increases quickly enough to overcome the deleterious effects of time decay.
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Conversely, a straddle seller risks just the opposite - potentially devastating loss
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es if implied volatility should increase dramatically. However, the straddle seller can
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register gains faster than just the rate of time decay would indicate if implied volatil
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ity decreases. Thus, it is very important when selling options - and this applies to cov
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ered options as well as to naked ones - to sell only when implied volatility is "high."
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A strangle is the same as a straddle, except that the call and put have different
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striking prices. Typically, the call strike price is higher than the put strike price.
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Naked option sellers often prefer selling strangles in which the options are well out
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of-the-money, so that there is less chance of them having any intrinsic value when
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they expire. Strangles behave much like straddles do with respect to changes in
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implied volatility.
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The concepts of straddle ownership will be discussed in much more detail in the
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following chapters. Moreover, the general concept of option buying versus option
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selling will receive a great deal of attention.
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CALL BULL SPREADS
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In this section, the bull spread strategy will be examined to see how it is affected by
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changes in implied volatility. Let's look at a call bull spread and see how implied
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volatility changes might affect the price of the spread if all else remains equal. Make
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the following assumptions:
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Assumption Set 1 :
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Stock Price: 1 00
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Time to Expiration: 4 months
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Position: long Call Struck at 90
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Short Call Struck at 110
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Ask yourself this simple question: If the stock remains unchanged at 100, and implied
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volatility increases dramatically, will the price of the 90-110 call bull spread grow or
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shrink? Answer before reading on.
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The truth is that, if implied volatility increases, the price of the spread will
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shrink. I would suspect that this comes as something of a surprise to a good number
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of readers. Table 37-6 contains some examples, generated from a Black-Scholes |