Why don't options get relatively cheaper as volatility increases?
- Thread starter wxytrader
- Start date
As Bollinger states times of high volatility is followed by times of low volatility. If this is true then the pricing model should factor this inevitable drop in volatility (price) during times of high volatility. The options can still increase in price, but should increase relatively less as volatility increases. On the flip side, options prices should increase relatively more in price as volatility drops.
The skew basically will have IV decrease as price goes from otm to itm...so options prices actually do get relatively cheaper as implied volatility drops off after the expected move is reached...so essentially as price goes up, volatility increases...but as price moves closer itm, volatility decreases so options get cheaper mimicking as if an expected drop of price is imminent. I see how it works now, and why there is a skew.
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In other words, as a successful trading strategy why don't people short the VIX when it reaches 40, or 50, or 60, etc.? I'm sure many tried that in March of 2020 and got burned horribly, despite it eventually turned lower. It can continued to remain at that level of volatility or increase for an unpredictable amount of time. I'm quite sure you also suffer from backwardation as you are trying to nail that top, even if the volatility doesn't lower.
Also, if you nail the bottom in terms of a rally, which I believe happened in March of 2020, the VIX doesn't always decrease for some time. When it keeps going higher you get burned hard too, it's not a small loss. Just putting out risks, certainly nailing the top of volatility would be very profitable but a lot of risk. I'm sure people like poopy and other option traders know 50 better ways to do this then shorting VIX, but thought it was the easiest example to think of the risk/reward in doing it.
Also, if you nail the bottom in terms of a rally, which I believe happened in March of 2020, the VIX doesn't always decrease for some time. When it keeps going higher you get burned hard too, it's not a small loss. Just putting out risks, certainly nailing the top of volatility would be very profitable but a lot of risk. I'm sure people like poopy and other option traders know 50 better ways to do this then shorting VIX, but thought it was the easiest example to think of the risk/reward in doing it.
It's almost a 100% guarantee that shorting the vix at 40.50.60 70 is going to be profitable as you can see from any chart that the vix has only touched 40 how many times and has stayed above 40 for how many trading sessions. I shorted VIXY 2 weeks ago and covered around 11 and change right before it spiked this past week. I will short once again this week above 15 if I can, not too many shares, if gets away from me I'll average down. These stocks always trend lower after they surge. Easier to short volatility than go long. I have gone long before, it rarely works.
First let me change your poorly worded title.
Why don't options get relatively cheaper as historical volatility increases?
Answer is they do when historical volatility does not predict future volatility.
For example, after an earnings release, there is something called IV crush.
I am referring to options pricing factoring in the probability of a drop in IV after an expected move, which they do via the skew. For example the MARA 20 strike call is 1.06 (104.61%) and the atm strike is 2.07 (101.78%). Even though the atm is more expensive, it is less expensive relative to what you paid for the 20 strike.
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Option pricing models such as Black-Scholes and binomial lattice do not factor in trend reversals (i.e., stock price reversing). There is no variable for drift.