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Sell options when volatility high? misleading?

Discussion in 'Derivatives' started by nerdzkilla, Feb 20, 2012.

  1. nerdzkilla

    nerdzkilla

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    "sell options when volatility high?"

    Is'nt the above misleading? because from what i just read.. when volatility decreases the ITM options will gain delta moving towards 100 and OTM options will loss delta moving towards zero.

    If today I sell ITM options when volatility is high and tomorrow the volatility collapses..i will lose money?!?

    Why cant we say something like

    If all else is expected to remain the same:

    A decrease in volatility is expected. sell OTM options
    An increase in volatility is expected. sell ITM options
     
  2. ROE

    ROE

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    High volatility = better premium so it logical that if you after premium
    you want to do it while there is high degree of volatility.

    and of course that has risk involve ie stock can drop way below your strike price ....

    volatility is only part of how options value is calculated...if volatility collapse it doesn't necessary mean you lose money, other variable are at play like stock price, time left on options contract, up coming dividend etc...
     
  3. village idiot

    village idiot

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    I think you are somehow confusing delta with price or value of an option, which it isnt. It is true that
    but that doesnt mean you are going to lose money, it just means your delta postion has changed.

    If either an ITM option's delta moves to 100, or an OTM options delta moves to 0, that means that all of the extrinsic (time) value has disappeared, meaning you have made as much as you can out of this position, (ignoring effect of market moves if you were not delta neutral). Congratulations, close the position and move on.




    because that is just not the case
     
  4. village idiot

    village idiot

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    I will give you an extreme example with figures taken from a theoretical option price calculator, for illustration

    S=100
    K (strike) =104
    say 30 days to expiry
    r=4%

    at IV=30% it would be

    call price = 1.964 call delta = .3539
    put price 5.622 delta = -.6461 ( i only use the minus sign to keep wayne happy)
    say you sell the straddle for 6.58. The call is OTM and the put is ITM , net delta = .2922

    Say, two days go by and IV collapes to 5%, now;

    call price = 0.002 call delta = .0046
    put price 3.683 put delta = -.9908

    so overall;

    call profit = 1.964-.002= 1.9602
    put profit = 5.622 - 3.683 =1.939
    the profits are almost identical for both the ITM and OTM options. that is because vega affects them both exactly the same.

    deltas have neared zero and 100 as you say, and this position is now mainly 'long' the underlying with a net delta of .99,but neither leg has lost money

    as the time value has almost disappeared, the theta will be amost zero as well , as will the gamma and vega, but i will leave you to do those numbers.




    worked 'what if" examples like that are the best way IMO to get your head round it. I recommend you should do lots of them, on every concept you can think of
     
  5. wayneL

    wayneL Rotaredom

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    The "Buy low volatility and sell high volaitility" is one of those simplistic generalizations that seminar clowns and book writers trot out. It's a bit like buy low, sell high when talking about trading stocks. What is low and what is high?

    An easy thing to determine... in retrospect.

    If you see high implied volatility, ask yourself why this is so. The theory is that volatility is mean reverting and high volatility will cycle back to low volatility in some sort of dependable rhythm.

    It ain't necessarily so. Volatility can stay high for a very long time. High IVs can also mean the market is expecting some sort of violent move and pricing that in (eg earnings, FDA approvals etc).

    Therefore, high volatility is not an automatic sell, nor is low vol an automatic buy, because as No Village Idiot points out, volatility does not exist in a vaccuum, it is just one consideration.

    Could not agree more. Get a modeler, Hoadley or whatever, learn how to use it and do as VI suggests, all the while watching real markets and how IV changes in reaction to movement and information.
     
  6. nerdzkilla

    nerdzkilla

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    Thank you so much guys..

    I have been following your advice religiously..initially i was just going to jump in and try things out but i have put that on hold till i get a complete picture of how greeks and volatiliy work....
     
  7. wayneL

    wayneL Rotaredom

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    Wise
     
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