The level of IV is definitely autocorrelated, but that's not important and not even relevant. What's really important is whether the IV rate of changes is significantly autocorrelated. Sadly enough, market efficiency strikes again and forced the latter autocorrelation to be economically insignificant. The end result: No consistent abnormal returns can be achieved using your idea!! Sorry..
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Implied Volatility autocorrelation
- Thread starter Rudolf13100
- Start date
The level of IV is definitely autocorrelated, but that's not important and not even relevant. What's really important is whether the IV rate of changes is significantly autocorrelated. Sadly enough, market efficiency strikes again and forced the latter autocorrelation to be economically insignificant. The end result: No consistent abnormal returns can be achieved using your idea!! Sorry..
dtrader98, thanks for the link. Their site seems very interesting too.
Rosy2, Thank you so much for telling me about R. I will download the software and will ckeck it out as soon as I have a little bit of time.
Rosy2, Thank you so much for telling me about R. I will download the software and will ckeck it out as soon as I have a little bit of time.
Quote from Thumama:
The level of IV is definitely autocorrelated, but that's not important and not even relevant. What's really important is whether the IV rate of changes is significantly autocorrelated.
Could you state it another way because I am not sure I understand? (I am new to this).
Are you saying that, if IV is relatively low, chances are that it will still be low in X period? And that if IV is relatively high, chances are that it will still be high in x second?
But that wouldn't be important and what would be important is whether a high momentum on IV will statistically remain in place in X period?
If you want to trade IV, then you have to become intimately familiar with its behavior. The IV of each contract has a distinct personality. Choose one and target it exclusively for a while. Get to know its personality inside out, backwards and forwards.
Let's start with the vix, since it's calculated for you and so much data is available. The first thing to know about the vix is that every time the underlying ticks up, the vix ticks down. Every time the underlying ticks down, the vix ticks up. That is true 99% of the time. I'm attaching a one-minute chart (each bar represents one minute) comparing the E-mini (top) to the vix (bottom) over the last 4 days.
Surprising how rigid that relationship is, isn't it? But that's not true in all contracts. Each contract has a completely different and distinct personality and behavior. Chart it against the underlying, against anything else you can think of. Compare the ATM vol against the otm put vol and otm call vol under different scenarios.
Most of this you'll just have to do on your own. If you do it enough, you just may begin to see recurring patterns and correlations. If you do, this is gold, because unlike iron condors etc., you're now looking at something that not everybody in the world is looking at.
Look at the chart I posted. Does anything stand out? Notice that on Friday after 11:30 the e-mini rose steadily without a corresponding drop in the vix. That's at least a bit unusual. Does it mean anything? Can you play it?
Let's start with the vix, since it's calculated for you and so much data is available. The first thing to know about the vix is that every time the underlying ticks up, the vix ticks down. Every time the underlying ticks down, the vix ticks up. That is true 99% of the time. I'm attaching a one-minute chart (each bar represents one minute) comparing the E-mini (top) to the vix (bottom) over the last 4 days.
Surprising how rigid that relationship is, isn't it? But that's not true in all contracts. Each contract has a completely different and distinct personality and behavior. Chart it against the underlying, against anything else you can think of. Compare the ATM vol against the otm put vol and otm call vol under different scenarios.
Most of this you'll just have to do on your own. If you do it enough, you just may begin to see recurring patterns and correlations. If you do, this is gold, because unlike iron condors etc., you're now looking at something that not everybody in the world is looking at.
Look at the chart I posted. Does anything stand out? Notice that on Friday after 11:30 the e-mini rose steadily without a corresponding drop in the vix. That's at least a bit unusual. Does it mean anything? Can you play it?
Attachments
Quote from Rudolf13100:
Could you state it another way because I am not sure I understand? (I am new to this).
Are you saying that, if IV is relatively low, chances are that it will still be low in X period? And that if IV is relatively high, chances are that it will still be high in x second?
But that wouldn't be important and what would be important is whether a high momentum on IV will statistically remain in place in X period?
On Friday 8-8-2008, the VIX index closed at 20.66
1. There is a high chance that next Monday it will close around this number ( for example, between 19 and 22 ). Does that help you to make any abnormal profit? I don't think so. This is called level autocorrelation (significant in this case)
2. The probability of the index moving up on Monday is 50%.Does that help you to make any abnormal profit? NO. This is called rate of change autocorrelation (insignificant in this case)
IMPORTANT:
You may find a way to predict the direction of the next index move, but it will only be statistically (not economically) significant. For example, you can find a way to say that the VIX index has a 53% chance of going up next Monday. However, after adjusting for all transaction costs, the economic signifcance of your ability to predict is close to zero.
Thumama..
Quote from Thumama:
On Friday 8-8-2008, the VIX index closed at 20.66
1. There is a high chance that next Monday it will close around this number ( for example, between 19 and 22 ). Does that help you to make any abnormal profit? I don't think so. This is called level autocorrelation (significant in this case)
2. The probability of the index moving up on Monday is 50%.Does that help you to make any abnormal profit? NO. This is called rate of change autocorrelation (insignificant in this case)
IMPORTANT:
You may find a way to predict the direction of the next index move, but it will only be statistically (not economically) significant. For example, you can find a way to say that the VIX index has a 53% chance of going up next Monday. However, after adjusting for all transaction costs, the economic signifcance of your ability to predict is close to zero.
Thumama..
Perfectly correct. No free lunch over there...
Quote from dmo:
If you want to trade IV, then you have to become intimately familiar with its behavior. The IV of each contract has a distinct personality. Choose one and target it exclusively for a while. Get to know its personality inside out, backwards and forwards.
Let's start with the vix, since it's calculated for you and so much data is available. The first thing to know about the vix is that every time the underlying ticks up, the vix ticks down. Every time the underlying ticks down, the vix ticks up. That is true 99% of the time. I'm attaching a one-minute chart (each bar represents one minute) comparing the E-mini (top) to the vix (bottom) over the last 4 days.
Surprising how rigid that relationship is, isn't it? But that's not true in all contracts. Each contract has a completely different and distinct personality and behavior. Chart it against the underlying, against anything else you can think of. Compare the ATM vol against the otm put vol and otm call vol under different scenarios.
Most of this you'll just have to do on your own. If you do it enough, you just may begin to see recurring patterns and correlations. If you do, this is gold, because unlike iron condors etc., you're now looking at something that not everybody in the world is looking at.
Look at the chart I posted. Does anything stand out? Notice that on Friday after 11:30 the e-mini rose steadily without a corresponding drop in the vix. That's at least a bit unusual. Does it mean anything? Can you play it?
DMO,
If I understand well you use the VIX as an indicator to trade the e-mini. you use divergences between the e-mini and the vix to tell whether the trend on the underlying is sustainable. In the case above, you would consider selling the e-mini and buying it back when the normal relationship resumes, is it right?
If I understand well you use the VIX as an indicator to trade the e-mini. you use divergences between the e-mini and the vix to tell whether the trend on the underlying is sustainable. In the case above, you would consider selling the e-mini and buying it back when the normal relationship resumes, is it right?
No, it's not enough to know when IV is relatively high, or relatively low.
If you expect clustering or mean-reversion in IV, so does the market. Options are priced consequently. You will have to beat the volatility term structure in order to make money, by anticipating implied vol more accurately than the term structure does.
Then it all comes down to ivol term structure modeling, which yes does usually require a Ph.D, unless you've learned how to solve PDEs in your finance undergrad at bschool.
Also, the 'direction' of the underlying doesnt have much to do with trading options.
And by the way, Forest Gump was not dumb.
If you expect clustering or mean-reversion in IV, so does the market. Options are priced consequently. You will have to beat the volatility term structure in order to make money, by anticipating implied vol more accurately than the term structure does.
Then it all comes down to ivol term structure modeling, which yes does usually require a Ph.D, unless you've learned how to solve PDEs in your finance undergrad at bschool.
Also, the 'direction' of the underlying doesnt have much to do with trading options.
And by the way, Forest Gump was not dumb.
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 Rudolf13100:
DMO,
If I understand well you use the VIX as an indicator to trade the e-mini. you use divergences between the e-mini and the vix to tell whether the trend on the underlying is sustainable. In the case above, you would consider selling the e-mini and buying it back when the normal relationship resumes, is it right?
At an absolute minimum, you need to understand the relationship between the VIX and the underlying, even if all you're doing is buying calls. Otherwise you're liable to buy those calls then wonder why you didn't make any money when the underlying went up as predicted. The same is true about understanding the idionsyncrasies in the relationship between any options contract and its underlying. Otherwise you are really trading blind.
Taking it a step further, yes, the VIX can at times help flesh out what's going on with the underlying. But there are certain details you really need to discover for yourself, or they won't mean anything to you. That's why I'm suggesting some things for you to look into. Successful trading is really about finding something that makes sense to you so you can see it for yourself and have confidence in it, and that suits your personality. Nobody can make money with someone else's system - at least not without figuring out some wrinkles of their own. If you explore and find a pattern or correlation yourself, then you'll really own it. I wish there was a shortcut.