IV to Estimate Future Price Range

[tradingjournals]

Quote from RPEX:

good effort, i have a question:

-When you created this did you consult the literature on extracting expectations from options prices / is it consistent with those methods.

1. The answer depends on the meaning of terms/framework one seeks/conceives of.

2. This might be a shock to some but I believe what is deterministic in the behavior of the stock returns would be "wiped out" in the option prices because its variance is zero.

 

[Van Halen]

Are you looking to do something similar to the attached?

Dotted green line is projected 1st std dev level for next 20 days, dotted red line is projected 2nd std dev level next 20 days.

Solid lines are the previous projected levels for reference on how the projections have done over time.

 

[Tahoe_Brent]

Quote from Van Halen:

Hi Van Halen, thanks for the comment.
Are the lines plotted in your image calculated with option data?

Brent

 

[Tahoe_Brent]

Quote from tradingjournals:

what if the months do not have equal implied volty? Extreme examples: What if 1 month implied volty = twice the 4 month implied?

That's a great point, and another feature for the software - which I think users have demonstrated has utility, by demanding support for that type of feature.

For example, most data terminals provide an IV for the underlying (without more information, my guess is that's what Van Halen's image was displaying in the two projected, or dotted, lines).
The underlying doesn't have an IV, so to produce one, the IV of its options are substituted.

To your point, accounting for variations in IVs of multiple contracts (calls/puts, strikes and time), combine IVs from various options. For example, weigh IV from the current month, near-the-money calls/puts, or a weighted contribution from subsequent months (eg., 75% current, 25% next month).

In any event, you're left with a distribution of what the market (investors) have priced (ie, are betting) the likely range of the stock will be in the future.

That could be used any number of ways. Our video demonstrated one use: The likelihood of a price change in the underlying being enough to warrant action (ie, hedging or closing a position).

However, it could also be used to open any combinations of new positions, based on one's independent analysis (ie, is the market mispricing the underlying, and if so, what position would best exploit that mispricing?).

At the end of the day, if your analysis indicates a $10 stock will be worth $20 in 3 months, but the prices of options indicate that as an unlikely possibility, then you have actionable information - just hope your analysis is more accurate than the market's

Thank you for the critique. I appreciate the insight, and would appreciate more.

Brent

 

[Van Halen]

Quote from Tahoe_Brent:

Quote from Van Halen:

Hi Van Halen, thanks for the comment.
Are the lines plotted in your image calculated with option data?

Brent

In that example (SPX) the calculations are based on the SPX and VIX. I find them to be very useful.

So far in 2013 we have only come close to closing outside the projected 2nd std dev one time.

 

[HurricaneUS]

Quote from Van Halen:

In that example (SPX) the calculations are based on the SPX and VIX. I find them to be very useful.

So far in 2013 we have only come close to closing outside the projected 2nd std dev one time.

just keep in mind that in this highly trending market everything looks perfect...heck you don't even need the indicators..just buy all the pullbacks


it works like a charm.......until it doesn't

 

[Tahoe_Brent]

Quote from Van Halen:

In that example (SPX) the calculations are based on the SPX and VIX. I find them to be very useful.

So far in 2013 we have only come close to closing outside the projected 2nd std dev one time.

Right. The point of the IV Gauge video is that very smart people price derivatives based on their expected future price ranges of the underlying - by extracting the only variable of option prices that requires estimation, one can measure the highest price (above intrinsic value) those people are paying for the underlying's likely price range.
Therefore, you don't need to engage in that activity to find it useful - but you do need to subscribe to OPRA data, and open a margin account

Has anyone reviewed the probability lab that IB just released, and if so, is there a fundamental - no pun intended - difference between that and the IV Gauge?

http://youtu.be/PUHjxM98SXw
https://www.interactivebrokers.com/en/index.php?f=5910

 

[drownpruf]

Quote from Tahoe_Brent:

I have a wireframe mock-up chart that plots a traditional chart with an underlying's history, but attaches its future expected range on the right, using IV.
http://youtu.be/mUvRA3O1mTw
The IV price range would change (up/down), based on:
1. The desired future period (eg, 1, 2, 3 mos, etc.) - the longer the period, the greater the range grows with time.
2. Which options are used to assign IV to the underlying (eg, using the front month's @TM P/Cs, or weighting same for several mos).
Any feedback would be appreciated.

Brent

Are you simply plotting the straddle premium and projecting a cone to the upper and lower break-even?

 

[Van Halen]

Quote from HurricaneUS:

just keep in mind that in this highly trending market everything looks perfect...heck you don't even need the indicators..just buy all the pullbacks


it works like a charm.......until it doesn't

I was not endorsing or denouncing the use of these type of projections. I was just showing a chart asking if that is what the OP was trying to accomplish with a one year chart as a reference.

The projections are not more or less valuable in a trending market which I think is what you are saying. They are just statistical projections. Another piece of information to consider in an overall trading plan.

I always like to know where we are at in regards to the projected std dev values. I do not view them as an "indicator" to tell me where price is going but more of where statistically price will NOT go. That can be even more valuable imo.

And in trading, everything works like a charm until it doesn't, not just these types of projections.