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Back by popular demand: stock market volatility!
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I was just going through some old articles, looking for something interesting to write today. I found this one. It is an article I wrote about volatility almost five years ago. I’ve left in the same numbers and charts as a matter of interest. The key message is ‘know your volatility’. Just what do you think you are selling? This article aims to address the idea that volatility is very important when selling options. It is something that a lot of beginners ignore but shouldn't. If you are one of those, please read on and you may just be convinced otherwise. One thing about selling options is you have to choose the right market in which to do it. all those stockbrokers telling the clients about buy-write strategies or those software systems that tell you how to sell a call and put spread in stock indices are simply getting it all wrong. Volatility in the stock market has been extremely low for some time. This translates to low option prices. Just take a look at the VIX Index a measure of US S&P500 Index option volatility from the CBOE (Figure 1). Figure 1:  Source: eSignal 7.6 www.esignal.com You can see here volatility is extremely low. In fact a percentage value of 20 used to be thought of as very low. Now it's at 16.1%! It is a similar story with other US indices and those around the world. What about in Australia? Take a look at News Corp - a stock known for it high volatility: Figure 2:  Source: OpenInterest V4 How about European markets? Figures 3, 4 and 5 show the German DAX, EuroStoxx50 and the UK's FTSE100. Just look at how volatility has fallen. Figure 3:  Source: Option Explorer Figure 4:  Source: Option Explorer Figure 5:  Source: Option Explorer So why do we care? Yes we know low volatility means low option prices, but just how low is low. As a simple example, I have modelled 60-day call option premium in the DAX at current implied volatility (set at 14.10%) and then used a value of 45% as seen in April last year.
The difference is huge AND these are based on real volatility numbers. Real numbers! All I have done is compared current November 2004 volatility with volatility from April 2003. That is the difference volatility makes! Given this doesn't it seem odd that people still persist in selling individual share and index options month in month out thinking it's a good strategy? Moving right along OK then let's stop living the past and look at the market in 2009. Here is a chart of the VIX - the CBOE's measure of option volatility in the S&P100. Figure 6  Source: eSignal 10.1 Does it look familiar? If it doesn't just scroll back up and look at any of the other charts. We are in a similar situation where volatility was high and now it's low (or at least lower). Trades that may have looked good six or seven months ago look a little different today. Now it is true that there is more to selling options that picking a market with high volatility. There is a lot more and it will not be explained in this article. However short listing high volatility markets is a great place to start. The real moral of this story is keeping an eye on volatility. Having certain volatility based rules for selling is a smart way to select trades. It may not always work. Nothing does. However, it does put the odds in you favour.  Disclaimer: There is a Risk of Loss in Futures Trading DISCLAIMER HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED THE RESULTS MAY HAVE UNDER OR OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. THE RISK OF LOSS IN FUTURES TRADING CAN BE SUBSTANTIAL. YOU SHOULD CAREFULLY CONSIDER WHETHER SUCH TRADING IS SUITABLE FOR YOU IN LIGHT OF YOUR FINANCIAL CONDITION. PAST PROFITS ARE NOT NECESSARILY INDICATIVE OF FUTURE PERFORMANCE. THERE IS A RISK OF LOSS IN FUTURES TRADING.THE INFORMATION CONTAINED HEREIN HAS BEEN OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, HOWEVER IT CANNOT BE GUARANTEED AS TO ACCURACY OR COMPLETENESS, AND IT IS SUBJECT TO CHANGE WITHOUT NOTICE. IT SHOULD NOT BE ASSUMED THAT THE SEASONAL PRICE TENDENCIES SHOWN HEREIN OR THAT THE SUGGESTIONS REGARDING THEIR USE WILL BE PROFITABLE OR THAT THEY WILL NOT RESULT IN LOSSES. PROTRADER LLC, ITS MEMBERS OR EMPLOYEES ASSUME NO LIABILITY IN CONNECTION WITH THE USE OF THE INFORMATION CONTAINED HEREIN. |
