IV Questions...

[FaderTrader]

I have some very basic options questions…

In this month’s Active Trader, there is a strategy outlined which posits using the IV of at-the-money options and converting the one-year time horizon of that IV to shorter time frames in order to create a channel based on 68 and 95 percent confidence intervals. I think this has some merit in understanding the level of the stocks that I follow within a particular industry (i.e., what are they all doing?).

I have some questions, though….

If today I take the IV of the at-the-money options of the underlying stock in order to do the calculation, assuming that I use end-of-day data for the price of the underlying and IV of the at-the-money option, if the price of the underlying changes so that a NEW strike is now at the money, do I take the IV from that new at-the-money option to carry out the next day’s calculation?

Also, what is the precise definition of an at-the-money option?

As a carrot: To anyone who can answer this question, I’ll gladly send you the excel model I’ve developed based on this strategy. All you’ll need to do is enter the price of the underlying, the IV of the at-the-money option and the number of days from now for which you’d like to calculate 68 and 95 percent confidence intervals and it will spit out the upper and lower boundaries for both of those confidence intervals.

(see attached)

 

[MTE]

Quote from FaderTrader:

I have some very basic options questions…

In this month’s Active Trader, there is a strategy outlined which posits using the IV of at-the-money options and converting the one-year time horizon of that IV to shorter time frames in order to create a channel based on 68 and 95 percent confidence intervals. I think this has some merit in understanding the level of the stocks that I follow within a particular industry (i.e., what are they all doing?).

I have some questions, though….

If today I take the IV of the at-the-money options of the underlying stock in order to do the calculation, assuming that I use end-of-day data for the price of the underlying and IV of the at-the-money option, if the price of the underlying changes so that a NEW strike is now at the money, do I take the IV from that new at-the-money option to carry out the next day’s calculation?

Also, what is the precise definition of an at-the-money option?

As a carrot: To anyone who can answer this question, I’ll gladly send you the excel model I’ve developed based on this strategy. All you’ll need to do is enter the price of the underlying, the IV of the at-the-money option and the number of days from now for which you’d like to calculate 68 and 95 percent confidence intervals and it will spit out the upper and lower boundaries for both of those confidence intervals.

(see attached)

I would take the new strike to do the calculation.

ATM strike is the one closest to the price of underlying. With that said, if it is somewhere halfway between the two strikes then I'd average them out and use that number.

 

[kny3]

I agree with MTE. Use the current at-the-money, average in & out if you're between the strikes.
Article (if it's the one I saw) pointed out that 68% and 95% just 1 & 2 standard dev's, probabilities of where the underlying "should" be (from where it is now). 2 examples in article I read had an Index - didn't move at all so that Iron condor worked well, and a stock - tested 2nd std dev but held that (i think).
Having a game plan using that type of thinking as you do so much better than just randomly picking o-t-m credit spreads.

kny 3

 

[FaderTrader]

Yea - I'm actually intending to plot the 1 and 2 Std Dev channels to get a sense of where all the stocks in my industry are going. If it's testing the top , I'm not going to short it necessarily, but I'll certainly be eager to get short a lot of shares if safety comes onto the offer.

Regards,
Fader

 

[FaderTrader]

Quote from kny3:

I agree with MTE. Use the current at-the-money, average in & out if you're between the strikes.
Article (if it's the one I saw) pointed out that 68% and 95% just 1 & 2 standard dev's, probabilities of where the underlying "should" be (from where it is now). 2 examples in article I read had an Index - didn't move at all so that Iron condor worked well, and a stock - tested 2nd std dev but held that (i think).
Having a game plan using that type of thinking as you do so much better than just randomly picking o-t-m credit spreads.

kny 3

Yup - we read the same article. So, correct me if I'm wrong on how I should go about this.

For the underlying, just the close price.

To plot the channels, just take the IV for the closest at atm option(s)? Can this be done through esignal or do I need to have someone program this through vba to draw from both esignal and optionvue?

Any advice would be much appreciated and I'd be happy to share when finished.

 

[kny3]

Yep, closing price or current price on the underlying.

IV for the closest a-t-m, or take a peek at the nearest o-t-m to see if you want to tweak it up a little. I wouldn't write a program to do this, #'s from either e-signal or optionvue should work. Keep in mind most programs take an average from the bid - ask to calculate IV. So if an option is 2 bid offered at 2.20 they use 2.10. If someone puts in a 2.10 offer (still 2 bid) they use 2.05.
It's not an exact science. The writer of the article moved a strike or 2 (don't have article handy) out of harms way on the put side of the stock example, and it turned out that he needed it!

kny 3