A review of IV (Implied Volatility) and its usefulness

[OddTrader]

Have you ever got any doubts, questions and comments on the measurement, correlations and usefulness of IV (Implied Volatility)?

An options trader can predict two things to make profits: (Forecast) Volatility of the underlying; and (Future) Volatility of its options.

Practically, general traders can only use Implied Volatility (based on options price) to project its own Future Volatility (against its own Historical Volatility of the options), as well as to project the Forecast Volatility of its underlying (against the 20-day Historical Volatility of the underlying).

And their correlations (of both Historical Volatility measures) can be found 'many times not frequently highly correlated'.

Obviously, an options price plays the most important role for the above dynamics. So the use of IV is basically a kind of:
- Self-fulfilling prophecy? or
- Faciltating manipulation of (options) prices? or
- Both? or
- Anything else?

 

[spindr0]

I don't think that option traders can predict anything. They can take positions that will make money if their volatility guess is right, but predict???

One thing traders can do is utilize positions that take advantage of IV levels. An example would be pre earnings spreads where the near month inflates more than later months.

 

[Martinghoul]

IV is just one thing and one thing only. It's an input into your rich/cheap model, whether it exists explicitly or just in your head. How this model of yours works, whether it's based on historical vol or something else, is another matter entirely.

 

[dmo]

Quote from OddTrader:

Have you ever got any doubts, questions and comments on the measurement, correlations and usefulness of IV (Implied Volatility)?

An options trader can predict two things to make profits: (Forecast) Volatility of the underlying; and (Future) Volatility of its options.

Practically, general traders can only use Implied Volatility (based on options price) to project its own Future Volatility (against its own Historical Volatility of the options), as well as to project the Forecast Volatility of its underlying (against the 20-day Historical Volatility of the underlying).

And their correlations (of both Historical Volatility measures) can be found 'many times not frequently highly correlated'.

Obviously, an options price plays the most important role for the above dynamics. So the use of IV is basically a kind of:
- Self-fulfilling prophecy? or
- Faciltating manipulation of (options) prices? or
- Both? or
- Anything else?

Oddtrader, if you spent half as much time studying options as you spend trying to convince yourself that it's really a waste of your time to study options, you'd be an expert by now.

If you want to understand implied volatility, watch my video "What is an option worth" at http://masteroptions.com/?p=3 It's free, but it will cost you 45 minutes of your time.

 

[OddTrader]

Quote from dmo:

Oddtrader, if you spent half as much time studying options as you spend trying to convince yourself that it's really a waste of your time to study options, you'd be an expert by now.

If you want to understand implied volatility, watch my video "What is an option worth" at http://masteroptions.com/?p=3 It's free, but it will cost you 45 minutes of your time.

Are you saying you are simply not capable to write down any of your thoughts or feedback regarding this thread at all? Or you are just afraid to do so (besides promoting your stuffff)!

 

[OddTrader]

Here are two posts I just found that could be of interest about the importance of IV in trading options.

"Implied Volatility autocorrelation"
http://www.elitetrader.com/vb/showthread.php?s=&threadid=133452

Quote from panzerman:

You don't need to be an implied volatility genius, with a Ph.D. in math to trade in volatility. Being a volatility Forest Gump will suffice i.e. knowing when IV is relatively high, or relatively low.

However, if you get the direction of the underlying wrong, it will be hard to make money with options, even if you get IV right.

Quote from domestic:

all my option trading involves a directional bet on an underlying.

you must mean direction does not have much to do with trading options relating to strictly volatility trading? even trading vix future spreads require a directional bias as one part of the reason to get into a switch. can you give a simple example of how one would trade an option for a positive p&l without a directional bias? of course i am speaking from a retail standpoint (thus no delta neutral trades).

 

[asiaprop]

both posts are utter nonesense. One of the distinct advantages of trading volatility over cash is the empirical evidence of serial correlation of implied volatilities, nothing else.

Those who cite volatility trading in combination with delta exposure or even gamma simply want to be overleveraged (for whatever reasons) or do not even understand the usefullness of variance or correlation swaps. Volatility trading is really what it means, exposure to only volatility by eliminating exposure to as many other variables as possible at the lowest possible price.
Enough said...;-)

Quote from OddTrader:

Here are two posts I just found that could be of interest about the importance of IV in trading options.

"Implied Volatility autocorrelation"
http://www.elitetrader.com/vb/showthread.php?s=&threadid=133452

 

[Martinghoul]

Quote from asiaprop:

both posts are utter nonesense. One of the distinct advantages of trading volatility over cash is the empirical evidence of serial correlation of implied volatilities, nothing else.

Those who cite volatility trading in combination with delta exposure or even gamma simply want to be overleveraged (for whatever reasons) or do not even understand the usefullness of variance or correlation swaps. Volatility trading is really what it means, exposure to only volatility by eliminating exposure to as many other variables as possible at the lowest possible price.
Enough said...;-)

Disagree...

I periodically put on trades that allow me to express a directional view through options. I daresay it's not because I don't understand or want to be overleveraged, but rather because I can kill two birds with one stone. Moreover, it has nothing to do with autocorrelation of vols. True, it's not purely vol trading, but I personally find trading pure vol rarely gives enough bang for the buck.

 

[asiaprop]

pure, implied, vol was the topic of this thread.

Secondly your comment on the limited profitability on trading pure vol can be easily refuted. It does not matter whether I trade an instrument that on average fluctuates by 1% per day or a levered fx position that causes variations in the account of 5%, 10%, xx% per day. It all comes down to edge and how much you lever up is all up to you. The edge, as I described, can be extracted by utilizing the serial correlation properties to some extent.

Its all cool how you trade options, but its still you who slightly missed the point of this thread not me...

Quote from Martinghoul:

Disagree...

I periodically put on trades that allow me to express a directional view through options. I daresay it's not because I don't understand or want to be overleveraged, but rather because I can kill two birds with one stone. Moreover, it has nothing to do with autocorrelation of vols. True, it's not purely vol trading, but I personally find trading pure vol doesn't give enough bang for the buck.

 

[OddTrader]

Quote from asiaprop:

Volatility trading is really what it means, exposure to only volatility by eliminating exposure to as many other variables as possible at the lowest possible price.

1. IV can be used not only for Volatility trading with options, but also for Directional trading using options.

I think IV is much more important in Volatility trading particularly when doing short-term trades. However less important in Directional trading particularly when doing long-term trades.

2. I don't understand how you can find and trade "at the lowest possible (options?) price".

Are you saying you can project the upcoming timing when the best (possible) price will appear eventually? And you don't make any trade if the best price does not come up within a period of time, then how long you would wait usually before giving up?

Quote from asiaprop:

The edge, as I described, can be extracted by utilizing the serial correlation properties to some extent.

As every market maker can make price using individual proprietary model based on preferred/ chosen serial correlation properties, I would think the importance of IV in option trading would be easily diminishing!