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Gary,
The general level of volatility in many instruments cannot be sustained.
The laws of physics, nature, most organized religions and almost every
state of the union make sustained levels of implied vol. in excess of
100% unlikely to continue.
Implied vol. .. as defined in the B/S option pricing model ....... is NOT
a measure of price change as many assume, but rather a measure of the
cost of Delta hedging. Over the years the dealers who buy/sell
volatility have changed their style of hedging dramatically. In the
1970's through 87 they were primarily Delta hedgers. Then the events of
1987 converted everyone to Gamma hedgers .... that failed in the mid 90's
and now everyone has essentially (on the dealer side) become vega
hedgers. This results in an interesting and usually controversial
trading phenomenon ........ which has lately generated a great many
profitable trading signals. It appears lately that when short term
actual vol. of an instrument exceeds the implied vol. in the options of
that instrument the underlying almost always rallies (a cautionary note
here I only trade S & P futures option and stocks and equity options so I
don't know if it works in all markets where an implied can be captured
... I can't trade OEX, SPX or NDX options.. but I'll bet it works there
as well. I haven't tried it because there is $$ incentive.
Overall vol. coming down SAYS NOTHING about market direction in the short
run ... in the long run that should be very bullish.
Take a five day trading history of an instrument (maybe a different
period would be better .. I don't know.. I use five days because it is
easily available when I travel). Say it is a hundred dollar stock just
to keep the numbers simple ..... then look at the trading range for the
period you study. Again to keep numbers simple let's say the daily range
is $5. Translates to 5% daily which translates to 80% annualized.
Annualized is daily X 16. Then go look at the ATM implied in the options
market and just for the moment say the implied is trading at 65%. Lately
this has almost always resulted in a S T rally. What appears to happen
during the rally is the two vols. come back into line with one another.
Why can't high vols. stay high? This is the obvious question and it came
up at my options seminar in Philly last night. Why can't stocks trade
100% vol. forever? Liquidity would rapidly disappear .... and overall
even though trading volume are huge right now liquidity is the worst I've
ever seen in my lifetime. Liquidity is not how much something trades ..
that is a bullshit measure. Liquidity is the ability to buy/sell size at
the quoted market. Take a stock like Dell as a classic example. It
trades millions of shares a day .... Is it liquid. Go try and buy 5,000
shares with a market order on a day when thing are a little bit hectic
and you'll find you can get a fill without moving the B/A.
I've been trading this over the past few months on a handful of issues
and I've been teaching it every chance I get and the follow - up I'm
getting from investors has led me to believe it is worth doing a lot more
work on this concept.
Gary Fritz wrote:
> I'm not an accomplished analyst. I'm a system trader. And my
> systems have been getting whacked for the past month, mostly due to
> volatility.
>
> It seems to me that the volatility has really increased lately. In
> the S&P there have been 6 15-25 pt swings, in less than an hour, in
> the last 6 days. None of them follow through with any kind of move.
> 10-20pt gap opens have become common. The ND is even worse.
>
> This raises hell with a short-term system that holds overnight and
> capitalizes on more sane moves. The market settles down for a day or
> so, lulling my system into complacency so it takes a position, then
> wham! There goes a 20-pt explosion, and I'm hit for another loss.
>
> Can someone comment on this? Do you expect this level of volatility
> to continue (or increase!?) for the near/forseeable future, or is
> this a short-term aberration? My system has never seen anything like
> this in its 3+yr history, encompassing several hundred trades.
>
> I can adjust my system to behave better in the market as it's acted
> for the last several months, but I'm nervous about changing something
> that has worked well for a long time. But if this market is going to
> keep acting like this, I need to change something or I'm going to be
> in deep trouble.
>
> For sure I'm going to have to start taking smaller positions, so at
> least I can go broke more slowly.... :-(
>
> Gary
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