Implied Volatility vs. Real Volatility

EliteTraderNYC · Jan 21, 2013

Is this a 1 for 1 long term? Over what timeframe?

antaram · Jan 21, 2013

I read somewhere that over last 20 years implied volatility has been higher than realized vol by an average of 4.5 or so points, in the last 20+ years implied volatility has exceeded realized volatility close to 90% of the time

nobody knows how this will go in the future

comintel · Jan 21, 2013

Quote from antaram:

I read somewhere that over last 20 years implied volatility has been higher than realized vol by an average of 4.5 or so points, in the last 20+ years implied volatility has exceeded realized volatility close to 90% of the time

nobody knows how this will go in the future

Assuming that that 4.5% excess figure is accurate, should one expect to be able to capture it by credit strategies, in view of periodically being stopped out on large sudden moves, transaction costs, etc.?

kapw7 · Jan 21, 2013

I guess in theory they should be the same (or very close) over a very short period of time (say less than 1 sec), the shorter the period the closer they get.

Over long periods they shouldn't necessarily converge. Implied vol is estimated in the risk neutral world.

kapw7 · Jan 21, 2013

Quote from comintel:

Assuming that that 4.5% excess figure is accurate, should one expect to be able to capture it by credit strategies, in view of periodically being stopped out on large sudden moves, transaction costs, etc.?

In this thread:
http://www.elitetrader.com/vb/showthread.php?s=&threadid=255405

there is an Excel spreadsheet by the OP with such strategy

cdcaveman · Jan 21, 2013

Don't miss reality here... one huge vol spike puts short variance guys out of business if to exposed.... its that small percentage of the time that you get killed... saying implies are higher then realized "most" of the time means nothing if you lose more then your gains on that rare event..... this "most" of the time bullshit is no reason to stay short variance ...

sle · Jan 21, 2013

Quote from comintel:

Assuming that that 4.5% excess figure is accurate, should one expect to be able to capture it by credit strategies, in view of periodically being stopped out on large sudden moves, transaction costs, etc.?

Simply being short gamma or short skew is a reasonable strategy overall, except an institutional trader would have been fired a few times over the last 20 years. Which is why selling vol is still a winning trade

cdcaveman · Jan 21, 2013

Quote from sle:

Simply being short gamma or short skew is a reasonable strategy overall, except an institutional trader would have been fired a few times over the last 20 years. Which is why selling vol is still a winning trade [/QUOTE

Its frustrating to me to know when to position long vol.. short pays well consistently... but knowing when to step out of the way or go long respectively seems the key to really killing it... being dead set on being a short vol/variance guy seems like your missing out on large sums of money....

sle · Jan 21, 2013

Think of another interesting factor while being long volatility - you are short convexity on your income, unless you are all in the upper bracket. For example, imagine that you are long gamma and lose money 3 years out of 4, but in the 4th year your end up making 100% on your capital. For simplicity sake let's say that your average return is about 20%, but you will end up paying top rate on your one good year and get very little relief in the 3 losing years. If, however, you are making 33% per year being long carry and end up flat in the 4th year - you will be paying lower absolute amount of taxes in your 4 years of trading.

cdcaveman · Jan 21, 2013

Quote from sle:

Think of another interesting factor while being long volatility - you are short convexity on your income, unless you are all in the upper bracket. For example, imagine that you are long gamma and lose money 3 years out of 4, but in the 4th year your end up making 100% on your capital. For simplicity sake let's say that your average return is about 20%, but you will end up paying top rate on your one good year and get very little relief in the 3 losing years. If, however, you are making 33% per year being long carry and end up flat in the 4th year - you will be paying lower absolute amount of taxes in your 4 years of trading.

ironic and funny i was sitting down at a restaurant with my father who is a CPA and owns an accounting firm when you wrote this.. basically what your saying is.. the non linearity of returns benefits the short gamma/short skew trader.. The long vol trader sees large returns only only seldom and in those years gets wacked hard in a higher tax bracket more then even losses from previous years can make up for..