Recently, after years of trading, I finally ask myself this question before I place any option trade. When I am right, selecting the option strategy is easy and the results are pain-free. When I am wrong, I lose. So, now I am trying to improve my VIX forecasting using reversion theory. Take the current situation. Two weeks ago, I believed that VIX would be flat or go lower..so I placed bull put spreads. I lost. I didn't really pay close attention to the VIX chart. At the time, the VIX was way below its six-month mean of 24. I should have realized this, and went with a long volatility strategy (long straddles, for example). I could have rode this trade up when the VIX finished around 28--it reverted to the mean and exceeded it. As of today, the VIX has dropped about 6.70% below its mean. Question: Will the VIX continue toward its lows only to revert back to the mean? I seems easier to forecast VIX than the underlying. Is VIX really that cyclical and predictable? Am I missing anything? If the VIX will continue downward, then obviously a short volatility strategy (like a long Iron Butterfly, short straddle, etc) would be called for. I would appreciate any comments, for I feel this is probably the most important aspect of options trading.
i mentioned this on another thread, but.... have you looked at vxx? its the etf of the vix. the recent surge in volume suggests vxx (&vix) could be making some waves in the not too distant future....
I like your suggestion. Gives us a chance to check volume behind the move. The chart for VXX really looks different than the VIX, though. Anyway, expected high volume on those huge up days, and low volume on the down days. Not sure how this helps. The VXX is at 30 or so. The six-month mean is about 45; so based on reversion theory, we would expect a move upward from here. The VIX chart suggests that the current VIX is a little below its mean--so looks like a conflict. When using the VXX, how accurate do you find it for forecasting volatility direction? Looking at it today, I would expect volatility to increase..so I would place long straddles on the ES (s&p 500 emini futures). Do you concur?
Be careful! VXX might not perform as you'd expect: VXX "offers exposure to a daily rolling long position in the first and second month VIX futures contracts and reflects the implied volatility of the S&P 500® Index at various points along the volatility forward curve." http://www.ipathetn.com/VXX-overview.jsp And..."The price of a VIX futures contract is to VIX what a thirty-day forward interest rate is to a thirty-day spot interest rate." http://cfe.cboe.com/education/vixprimer/Basics.aspx <img src=http://www.elitetrader.com/vb/attachment.php?s=&postid=2718305>
Are you talking about placing trades on the price of the VIX itself, or are you placing trades on some broader market index?
I too am watching the IV on google as it heads south from the 29-30 down to 24 and am looking for that 20-21 number as one signal that its time to buy. I believe reversion to the mean principles, especially over a long period of time are a powerful confirmation tool. Are they infallible? Of course not but it seems that if I buy options in the 3-6 month range I find that I am usually in the money to the point where I have decisions to make about whether to stay in a trade or take profits.
February IV for GOOG: 22.71; March IV: 24.09; June IV: 25.8. So, what are you buying? As IV decreases, option prices decrease; as IV rises, option prices rise. So, once the IV hits that low "magic" number, then buying a put or long straddle makes sense. I do agree that long-dated options for going long is best, for they are little affected by time, but more sensitive to volatility. Since I stink at forecasting direction of the underlying, I would probably buy a long straddle and exit when the IV overshoots the mean on the way back up.
JWCapital: I agree thats one way of doing it where you buy a straddle but you need a bigger move to offset the losing side. I typically try to predict direction with a spread or a call or put purchase. On a call or put purchase I am willing to lose 50% on a trade (1% of trading capital) and no more and Im out. On winners I am looking to at least double my money and I have about 60% losers. If I make the money quick I will take some off the table to insure an overall profit. If Im seriously ahead like 3- 4x money I ask myself would I still be a buyer for this option at that price? If the answer is no Im out. The technicals and the fundamentals have to line up and I do not day trade because then your competing against market makers and pros and you might as well go to Vegas. On spreads I like credit spreads and am hoping for an 80% win rate and on the 20% losers I try to get out asap and have never once experienced a maximum loss. Pretty conservative and not very exciting and Im trying not to gamble or give in to an adreniline rush. The flip side is the pros do not trade long term so they are not competition. We get to pick our battles and when and the vix is a confirmation tool when all else looks good. How I see it. Sorry to be long winded.
VIX way up today and that trend is the way for the foreseeable future. I think we may see a VIX in the 40's again which will be great for optinos writers, even if the volatility makes their jobs a little harder.