Volatility Trade

I'd like to know your thoughts on the proper way to trade volatility. For example, I was taking a look at VXGN and was wondering what would be the best strategy to implement in order to capture an expected rise in volatility?

IV is currently around 73 and lets say I expect volatility to increase to 90. Is a straddle the best strategy? How about a strangle? Should you ensure you're delta neutral? What is absolute critical in this trade? What makes this a good or bad trade? I'm not interested in playing this one, only wanted to use it as an example.

I know I'm new at this greek thing, but I'm trying to learn. Many thanks for your input.

 

Did you know that on Friday the VIX futures contract will start trading? You'll be able to make a straightforward bet on overall market volatility.

For VXGN volatility specifically, you might want to go long a long-dated, delta neutral straddle. You buy both a call and a put. All else being equal, the options will increase in value as the implied volatility increases. You want to buy both the call and the put to offset your exposure to rising or falling prices — you want to be delta neutral. And then you want to by long-dated options (ones that don't expire for several months) to minimize the time decay in the value of your options.

Let us know how it works out and good luck!

 

I read the best time to purchase straddles and strangles is when implied volatility of the options is low. IV tells the trader if premiums are low (cheap) or high (expensive).
My question is how (or where) we can compare the current implied volatility and the stock’s historical volatility to determine if implied volatility is high or low.

Thanks for your help

 

You can compare with what volatility a certain underlying has been moving. But beware, when you trade an option your result is exposed to the volatility of the future and not the past. Sure, there is a great deal of autocorrelation in realized volatility. But it isn't all that stable at all and the extreme event is always looming out behind the corner, ready to thwart your calculations.

My advice, do include past volatility in your calculation if you want to, but let it not be the determining element of your pricing. Also, don't go looking a year back if you consider trading options that expire in a month.

Look at the historical vol. Then look at the implied one. Why is it so high? What news releases are there to come? Have there been rumours? Is there fear? Then think again. And maybe trade.

 

Thanks for your advice, Sabotage,

For a week I've bought a long strangle but now I found out the legs were expensive when the underlying returned to the original price level (where I purchased the strangle) and the legs were cheaper. Since the options were long term, time decay didn't effect the premiums. I decided next time before buying I'll check the price status of options.
Where can check the IV of an underlying stock?

 

I myself have been interested in this particular strategy of trading volatility. I used to hang with some pit traders in the grains at the CBOT who played in the grain options. They were bouncing off such terms such as skew and volatility smile. I know what skew/kurtosis and the vol smile is now, but are there additional resources that one can peruse on the topic of using vol smile, skew, etc to trade instruments?


Thanks,
C

 

Koppanyi,

You can check the implied volatility for a given underlying (or to be precise, of the options on the underlying) on Bloomberg. I think it is something like, for example, MSFT US Eqty OMON. Maybe there is some information available for free at ivolatility.com.

It is probably easier to track down some option prices and deduce the implied volatility yourself.

With regards to your straddle trade - if you want to capture volatility in the market rather than a one way move you need to trade some deltas on it. If you buy the 10 straddle in some stock, when the stock moves to 11 you will have long deltas - sell some, make yourself flat even, if you want. You have locked in some profit. From then on it can go up or down, you will get the right deltas because of the premium and you can hedge again. Of course, what the best hedges are (if any) can only be said post factum...

 

Hi Sabotage,

I visited on Bloomberg but I miss "OMON". Ivolatily's chart is better .

Thank you!

Koppanyi