Hi, Was reading this: http://www.schaeffersresearch.com/sentiment/pdfs/sentiment_2012_Summer.pdf. There is a section later on about implied vol. It says: "Options on stocks with low implied volatilities do not need ot make very big moves to yield an attractive profifts, ...." Could someone explain why this is? Is it because the Iv was low, the options themselves were low and so you can get closer to ATM, resulting in a large move in the value of the option itself increases? Thanks, AIJ.
You don't have to be a rocket scientist to figure it out. Just price the 1 strike OTM options and figure out how much the underlining as to move to double the option price. In some cases a 0.5% move on the QQQ will be enough the double some options, as in the case of the 70.50 calls that expire today. They were going for $0.07 yesterday and could have been sold for $0.14 this morning.
A good way to think of it is that all moves are relative to the level of the implied volatility. So, if the annualized implied volatility is 16%, you only need 1% daily move to break even, while if it's 48% you need it to move 3% a day.
diaoptions, thanks for the response. I keep thinking about what happens at expiry, and forget about th efact you can just trade the options themselves, and their prices move at the higher %. Admittedly, you highlight a good point (or area) in which I am lacking - I am not sure how to work out how much the underlying would have to move to cause the OTM option to double in price. Given its OTM, all that price movement is greek-based premium isnt it? I am still early days on working out how these things affect price....lame I know
AIJ, The answers you got were correct, but I just wanted to answer this in another way that might be clearer, or may not be. Looking at 2 stocks both at $50, with one having a high IV and the other having a low IV, you might find these prices: High IV stock - 50 Call 2 months out - $500 Low IV stock - 50 Call 2 months out - $125 Now, if both stocks were to move to $60 at expiration, each 50 call would be worth $1000. However for the high IV stock, you just made a double, but the low iv stock was an 8 fold gain. Yes, that is just at expiration, but even look at a lesser move before expiration. Say they each went to $52.5 in a few days. The quotes might now look like these: High IV stock - 50 Call 2 months out - $700 Low IV stock - 50 Call 2 months out - $325 Each call would have gained $200, but the low IV call only cost $125 in the first place. Now after reading this, a person might think they should always buy the low IV options. However, the high IV stocks can actually be much more likely to make a solid move then a low IV stock. In reality, that low IV stock might barely move 25 cents in a few weeks. The examples are just meant to show how an option can profit quite a bit from a reasonably small move in a low IV stock (such as the question). JJacksET4
Hi JJacksET4, Your explanation is very helpful. The calculations make total sense, i wasnt thinking. I apprciate you explaining it, its much clearer. Thank you, AIJ
your asking the right questions.. not lame... there are several variables that affect the pricing of options.. a combination of supply demand and the actual underlying moving are the main factors and they are measured in greeks such as theta, vega, gamma, delta..... its not as complex as some people think... theta tells you how much money you will be making if your short it or how much you'll be burning if your long it.. long calls your going to experience the draw down based theta... vega is how much the option will change in 1 percent change in implied gamma is how much the delta will change with a move in the underlyiung... delta is how much price of the option will change with a move in the underlying... i just kept reading..and askign questions.. and asking more questions and then asking for clarification.... there are higher level greeks as well but the whole idea when you buy or sell an option is your expressing something about their pricing... if you sell you believe that they are implying to much of a move in the underlying.. if you buy them your expressing a view they are under priced related to the move they are implying... implied volatility is how much volatility it would take to make sense of buying that option at expiration.... your implying something when you buy or sell... everything is relative.. low iv stocks can be over priced at super low iv levels.. just as heavy movers like goog could be underpriced even though the iv is super high. short vol=net short premium long vol = net long premium... why i say net.. because there are alot of combination strategies that are short vol yet still have long premium legs to them.. condors , butterflys etc..