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Archive for January, 2011

The ABCs Of Option Volatility

18 Jan

Article by: John Summa, CTA, PhD
Published by: Investopedia
Date: Apr 2009

“Most options traders – from beginner to expert – are familiar with the Black-Scholes model of option pricing developed by Fisher Black and Myron Scholes in 1973. To calculate what is deemed a fair market value for any option, the model incorporates a number of variables, which include time to expiration, historical volatility and strike price. Many option traders, however, rarely assess the market value of an option before establishing a position. (For background reading, see Understanding Option Pricing.)

“This has always been a curious phenomenon, because these same traders would hardly approach buying a home or a car without looking at the fair market price of these assets. This behavior seems to result from the trader’s perception that an option can explode in value if the underlying makes the intended move. Unfortunately, this kind of perception overlooks the need for value analysis.”

Full article: Link

 
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Posted in Implied volatility, Trading ideas

 

Volatility Arbitrage Indices – A Primer

12 Jan

Article by: Keith Loggie
Published by: Standard & Poor’s
Date: Jul 2008

“In broad terms, volatility arbitrage can be used to describe trading strategies based on the
difference in volatility between related assets, for instance the implied volatility of two
options based on the same underlying asset. However, the term is most commonly used
to describe strategies that take advantage of the difference between the forecasted future
volatility of an asset and the implied volatility of options based on that asset. This
strategy is often implemented through a delta neutral portfolio consisting of an option and
its underlying asset. The return on such a portfolio will be based not on the future returns
of the underlying asset but rather on the volatility of its future price movements. Buying
an option and selling the underlying results in a long volatility position, while selling an
option and buying the underlying results in a short volatility position. A long volatility
position will be profitable to the extent that the realized volatility on the underlying is
ultimately higher than the implied volatility on the option at the time of the trade.”

Full article (PDF): Link

 
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Posted in Implied volatility, Realized volatility, Trading ideas

 

The Benefits of Managed Futures in the Post-Lehman, Post-Madoff Era

05 Jan

Article by: E. Bruce Mumford
Published by: 2100 Xenon Group
Date: 17 Dec 2010

“An investor considering an allocation to managed futures recently asked me if the Lehman Brothers’ bankruptcy and the collapse of Bernard Madoff’s fraudulent investment firm had been good or bad for the futures industry. There is no single or easy answer to that question.

“In 2008, these events shocked the global markets in different ways. Lehman and Madoff were “bad” in terms of the damage they inflicted on people’s portfolios and how they eroded investor confidence. The fallout from these losses will likely be felt for years to come.

“The important lesson learned—namely the need for a well-diversified, transparent, reasonably liquid portfolio—is the “good” thing that sprang from these events and the market turmoil of recent years.”

Full article (PDF): Link

 
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Posted in Investing ideas

 

Lack of liquidity means a comeback for vol swaps

04 Jan

Article by: Matt Cameron
Published by: Risk magazine
Date: 28 Jul 2009

“Dynamic replication of the payoff of volatility swaps on single stocks in illiquid markets is cheaper and easier than replicating variance swaps payoffs, dealers say.

“Activity in variance swaps has died down after volatility spiked in late 2008, causing many dealers to experience hefty losses, particularly in single stocks. The resulting pull-back has spurred dealers to search for other ways to offer volatility trades where clients are not required to delta-hedge options. Dealers such as BNP Paribas are actively pushing volatility swaps as a viable alternative.”

Full article: Link

 
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Posted in Implied volatility, Trading ideas