Not all volatility is equal. It is important to distinguish between historical volatility and implied volatility, so retail traders can learn how to trade options, with a focus on the substance of the theoretical price option spread.
Historical Volatility [HV] measures past price movements of the underlying asset and records the actual or actual volatility of the asset. The more common type of HV is statistical volatility, which calculates the underlying asset return over a limited but adjustable number of days. Let me explain the meaning of "limited but adjustable". You can change the number of days that measure statistical volatility: for example, 5-10-50-200 days, which is how time-based moving averages and momentum/oscillator studies are built. However, implied volatility is not the case.
Implied volatility measures the expected value by repeatedly raising the valuation of the sale. These estimates are based on the expectations of the buyer and the seller. Both buyers and sellers [more than 85% of the floor volume is driven by institutions, floor traders and market makers] support the value of the sale, they did change their estimates on the same day, because the new information is macroeconomic news or micro-can Obtain economic data that affects the underlying products. Estimates are future fluctuations in underlying assets, some of which are embedded in changes in underlying information. Improvements to the valuation of the sale and purchase must be completed within a limited time-limited option expiration period. This is why the monthly and quarterly option expiration cycles. You can't change these expiration dates by shortening or extending the number of days, and "Building" gives you a time period for faster or slower cross-metrics.
Why point out the misuse of historical volatility and implied volatility? from
This is a warning that you should not use the HV-IV crossover, which is not a reliable trading signal. Keep in mind that for a given expiration month, there can only be one volatility during that particular period. Implied volatility must start at the current trading position and converge to zero on the expiration date. Implied volatility [IV for ITM, ATM or OTM strikes] must return zero at maturity; however, prices can go anywhere [up, down, or remain steady].
Continued selling of "overpriced" and buying "underpriced" options will ultimately result in a complete alignment of the implied volatility of each non-zero buy option. This means that the "smile" tilt of the IV disappears because the IV becomes completely flat. This is hard to happen, especially in high-flow products where SPY is an example, which is a broad-based index; or, GLD-SPDR shares ETFs in fast markets like Gold. Open to thousands of non-zero bid strikes, do you really think that over-the-counter retailers will be allowed to "low-cost" professional hedging on the floor? Not too possible. The calling and delivery of high-mobility products, like the items in stock, is very large because of the high demand. This type of inventory will not be "wrongly priced" because floor traders must conduct daily life through trading calls and bets - they will refuse to bear the risk of mispricing overnight.
So, as a retail trader, what are your key considerations for banking?
- For ATM and OTM strikes, IV has a much greater impact on the percentage of the external value of the option, while the ITM strike has intrinsic value but lacks extrinsic value. Most retail options traders have accounts ranging from $25 to $50,000 [or lower], and they tend to strike at ATMs and OTMs due to affordability. The deeper the ITM, the wider the bid-ask spread, and the ITM strike costs are higher compared to the smaller bid-ask spreads in ATM or OTM strikes.
- When you conduct an IV trade, you will purchase a time decay to raise the IV at the following % point; or a time premium of a price drop of a percentage point below the theoretical price of the market value, the participant is willing to pay or sell. According to the market scope of the day, the price debit spread is expanded to below the theoretical price of the difference of 0.10-0.15. With credit spreads, raising credit to sell spreads is 0.10-0.15 higher than the theoretical price of spreads. The price you pay is lower than; or, the gain above the theoretical spread is your advantage, purely based on the implied volatility of the price performance. Remember, you theoretically priced a spread to fill its forward-looking value and never fall behind.
Please click on the link below titled "Consistent Results" to see the portfolio of model retail options traders, excluding the use of HVs, and focus on trading IV only.
I will cite these actual historical events to support the argument that historical fluctuations are completely eliminated from the trading process.
February 27, 2007: The panic caused by the sharp sell-off in China's stock market is widespread. If you are trading index options like FXI, this is the iShares product of the 25 largest and most liquid Chinese companies in China, although listed in the US; but they are based in China and you will be affected. While you can say that it is possible to make market events reproduce the scope of Dow, Nasdaq and Standard & Poor's, how do you reproduce the 59% and 39% scenarios of VIX and VXN soaring?
January 22, 2008: The Fed cut interest rates by 75 basis points before the scheduled policy meeting on January 30, and the FOMC cut another 50 basis points on the day of the meeting. If you use a financial ETF or a bank index [such as BKX] options to trade interest rate sensitive industries; or a housing index like HGX, you will be affected. In an environment where the current interest rate is close to zero, the FOMC still has interest rate policy tools, but they cannot cut interest rates with the same number of benchmarks as before. What is a historical event will not be repeatable in the future until the interest rate is raised again and then cut again.
Question: How do you rebuild history? This is the history of events that have historically fluctuated. The answer is in the referenced instance, just like any other financial-related historical event - you can't rebuild history. You may be able to imitate the HV part, but you can't repeat it completely. So, if you continue to use the HV-IV crossover, you will visually confuse yourself by searching for the volatility "wrong pricing" model you want to see; however, you will end up with poor earnings performance. Purely focusing on IV makes the meaning of the transaction more practical; then, volatility transactions across multiple asset classes are spread out of stock.
Where can I learn more about trading options IV in multiple asset classes using only options without having to own stocks? from
Please click on the link below [video-based course], which uses IV mean regression/average exclusion and IV prediction as a reliable method for trading the volatility of broad stock indices, commodity ETFs, currency ETFs and emerging market ETFs.
Orignal From: Options Trading Strategy - Misuse of historical volatility and implied volatility
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