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Ira,
On Date: Thu, 21 Mar 2002 10:25:16 -0800, you wrote:
"From: Ira Tunik <irat@xxxxxxxxx>
Subject: Re: For the folks with VIX interest
Could it be that the market makers and others know where the tops and
bottoms are in the market. For the VIX, the implied volatility of the
OEX, to be low would mean that selling was driving the options prices
down. Conversly, does someone know that the bottom is in place in order
to come in and buy the options and force the VIX to highs. It is the
buying and selling of options that controls the VIX, so when options
buyers are most optomistic it is a low and when they are most pessemitic
it is a high. Could this be true? Could someone actually know what was
going to happen next. But it would take a lot of people to effect the
VIX, so everybody knows? Ira"
This is based on my experience trading option spreads on the FTSE 100
index.
It may or may not have relevance to other markets and has been simplified
for ease of discussion.
Let us look at an unbalanced trade in options from a market makers
perspective.
When the market is rising, some long term holders of stock sell calls
(covered call selling) to gain extra income and some limited downside
protection.
If the underlying continues to rise, eventually this trade in outsiders
selling calls becomes a significant part of the options
trading.
Market makers are happy, at first, to take the other side of this trade
as they are buying calls into a rising market.
After the market has risen a lot more, and covered selling increases
substantially, the market makers become less and less willing to take the
other side of the trade (buying out of the money calls) as they know from
experience of persistence of market movements, the underlying rise is
increasing likely to falter and turn. And they do not
want to left as long holders of some worthless calls.
So they respond naturally to this by:
- reducing
prices as supply increases (lower implied),
- reducing
prices as they become progressively less willing to be long out of
the
money calls.
As the prices of one type and strike-set tends to impact most options on
the same underlying by call-put parity etcetera, all implieds tend to
fall as the underlying rises.
The net effect is a steady reduction in implied.
Now let us look at a falling market. It matters not whether
there is a long slow relentless fall or a fast fall in the
underlying. Long term stock holders become nervous and
start to buy puts to protect their positions.
At first, market makers are happy to sell a few puts they accumulated
earlier into the prior rise and ever decreasing implied.
As the underlying continues to fall, the urgency of stock holders
increases and they want more puts to protect their portfolios.
Now the market makers respond to the increasing demand for put buying
by:
- increasing
prices as demand increases (higher implied),
- increasing
prices as they become progressively less willing to be short of
out
the money puts,
Usual argument about prices of one set of options impacting prices of
most options for same underlying.
So implied tends to rise as the underlying falls.
Implied volatility can also change due to expectations of a big move in
the underlying following an expected announcement.
Implied volatility can also change due to a prolonged fall in actual
volatility of the underlying or a prolonged period of dramatic movements
in underlying.
So what we see as implied pattern perhaps tends to be a compound of three
factors and no doubt many others I am not aware of:
- recent
direction of movement in underlying,
- expectations
of a major announcement,
- actual
volatility of underlying.
As some of these factors can reinforce each other or negate each other,
patterns in implied volatility can be very difficult to identify without
isolating the three main factors etc.
May your potential be realised, Ric.
www.traderscalm.com
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