Trading volatility

Résumé du document

Traditionally, to make a profit, most individual investors and fund managers are forced to take a view on the direction of the price of something. The traditional or fundamental strategy is to study all the aspects of the market-place, all the factors affecting the price or that might affect the price. In addition, many also consider what are known as the technical factors. Technical analytic methods use the sequence of previous prices to come up with an investment recommendation. However, whether following fundamental analysis or technical analysis or a combination of both, the ultimate investment decision is that one has to buy or sell something. The traditional investor has to take a view on the direction of the price. Most investors then focused on their respective stock markets. With the growth of the derivatives industry, investors now have a choice.

Extraits

[...] The simplest form of measuring statistical volatility would be to take the standard deviation of the asset over time). These two concepts are important because if for instance, the implied volatility of an option contract is particularly high while at the same time the statistical volatility has not budged much, it is an indication that the option is overpriced. Therefore, selling the option is warranted. The reverse also holds true. c. Causes of Volatility Volatility is seen to be as a result of trading. [...]

[...] They are a good strategy to pursue if an investor believes that a stock's price will move significantly, but is unsure as to which direction. The stock price must move significantly if the investor is to make a profit. A small movement in price in either direction will result in a loss to the holder as it can not compensate for the premium already paid and as such is risky to perform. Additionally, on stocks that are expected to jump, the market tends to price options at a higher premium, which ultimately reduces the expected payoff should the stock move significantly. [...]

[...] Like any other asset, volatility may be overpriced or underpriced. a. Buying and Selling Volatility While the price of the underlying and the time are clearly defined variables, volatility is difficult to estimate. To buy or sell volatility involves constructing a portfolio of at least two instruments. In its simplest form, the portfolio will have positions (long or short) in the stock and derivatives of the stock.Examples include: futures, call options, put options, warrants and convertible bonds. Portfolios constructed to exploit volatility will always have opposing positions in stock and stock call options. [...]

[...] A profit is made if the underlying price is close to the strike at expiration. Here, the investor thinks the markets are unlikely to move much between the purchase and expiry of the options. A position in a short straddle position is highly risky, because the potential loss is unlimited. The profit is only limited to the premium received by sale of the options. Selling straddles might seem attractive because of the initial premium but should be undertaken by a well- capitalized trader as sudden movements in price results in huge losses. Strangle 1. [...]

[...] If we had not acted at Z and rehedged there would be no profit. The rehedging process locks in the original profit and sets up a situation in which further profits can be made. Shorting Volatility If the options are expensive enough one may choose to take the opposite position and sell volatility. The short volatility strategy is exactly the opposite of the long volatility strategy in every respect and obviously can, in the right circumstances, produce profits. The basic strategy involves selling call options short and hedging with a long position in the stock . [...]