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Showing posts from November, 2017

"The Strangest Thing..."

A few weeks ago I wrote an entry about the historical context of current equity volatilities. The conclusion was that volatility is low (startling I know), but if we compare it to the years from the pre-VIX era it isn't quite the extreme outlier it appears. Since 1950, two years have had lower volatilities (1964, 1965) and four others (1952, 1963, 1972, 1995)  are about the same.

But 2017 is unusual in a couple of other ways. First, the ratio of absolute value of return to the realized volatility is very high. Volatility is low but we have actually moved a fair distance. As of mid-October, the S&P 500 annualized return to average 20-day volatility ratio was 3.07 (return of 21.5% and a volatility of 7%). The average ratio since 1950 has been only 1.29. Only 1954, 1958 and 1995 have had higher ratios.

Even more extreme is the ratio of maximum draw-down to realized volatility. The average value has been 0.99. So far this year the number is 0.4. The biggest draw-down has been onl…

Straddles and Strangles Part 1

This is essentially a re-post of an entry from the (now dead) FactorWave blog. It is relevant again because it is the first part of what will be a series on strike and strategy selection.
One of the things that make options great is that there are many ways to express an opinion. But this is also one of the things that make options tricky. Just because there are many ways to express an opinion doesn't mean they will all be equally good. Some will be a lot worse than others.
Let's assume implied volatility is too high. While there are many ways to trade this, the two simplest are to sell either a straddle or a strangle. Here we are going to compare there two strategies. It is easy to work out the expected profit of an option position. It is just the position value at the volatility we sold at, minus the position value evaluated at the realized volatility. But obviously this doesn't tell the whole story. When selling options our upside is capped by the collected premium, but…