40 lines
3.0 KiB
Plaintext
40 lines
3.0 KiB
Plaintext
Chapter 36: The Basics of Volatility Trading 135
|
||
might not seem all that attractive. That is, if the first percentile of XYZ options were
|
||
at an implied volatility reading of 39% and the 100th percentile were at 45%, then a
|
||
reading of 40% is really quite mundane. There just wouldn't be much room for
|
||
implied volatility to increase on an absolute basis. Even if it rose to the 100th per
|
||
centile, an individual XYZ option wouldn't gain much value, because its implied
|
||
volatility would only be increasing from about 40% to 45%.
|
||
However, if the distribution of past implied volatility is wide, then one can truly
|
||
say the options are cheap if they are currently in a low percentile. Suppose, rather
|
||
than the tight range described above, that the range of past implied volatilities for
|
||
XYZ instead stretched from 35% to 90% - that the first percentile for XYZ implied
|
||
volatility was at 35% and the 100th percentile was at 90%. Now, if the current read
|
||
ing is 40%, there is a large range above the current reading into which the options
|
||
could trade, thereby potentially increasing the value of the options if implied volatil
|
||
ity moved up to the higher percentiles.
|
||
What this means, as a practical matter, is that one not only needs to know the
|
||
current percentile of implied volatility, but he also needs to know the range of num
|
||
bers over which that percentile was derived. If the range is wide, then an extreme
|
||
percentile truly represents a cheap or expensive option. But if the range is tight, then
|
||
one should probably not be overly concerned with the current percentile of implied
|
||
volatility.
|
||
Another facet of implied volatility that is often overlooked is how it ranges with
|
||
respect to the time left in the option. This is particularly important for traders of
|
||
LEAPS (long-term) options, for the range of implied volatility of a LEAPS option will
|
||
not be as great as that of a short-term option. In order to demonstrate this, the
|
||
implied volatilities of $OEX options, both regular and LEAPS, were charted over
|
||
several years. The resulting scatter diagram is shown in Figure 36-3.
|
||
Two curved lines are drawn on Figure 36-3. They contain most of the data
|
||
points. One can see from these lines that the range of implied volatility for near-term
|
||
options is greater than it is for longer-term options. For example, the implied volatil
|
||
ity readings on the far left of the scatter diagram range from about 14% to nearly 40%
|
||
(ignore the one outlying point). However, for longer-term options of 24 months or
|
||
more, the range is about 17% to 32%. While $0EX options have their own idiosyn
|
||
cracies, this scatter diagram is fairly typical of what we would see for any stock or
|
||
index option.
|
||
One conclusion that we can draw from this is that LEAPS option implied
|
||
volatilities just don't change nearly as much as those of short-term options. That can
|
||
be an important piece of information for a LEAPS option trader especially if he is
|
||
comparing the LEAPS implied volatility with a composite implied volatility or with
|
||
the historical volatility of the underlying. |