interactive brokers webcast – october 16, 2013 ... · pdf fileimplied volatility is...

UnderstandingImplied Volatility Russell Rhoads, CFASenior Instructor – The Options Institute

Interactive Brokers Webcast – October 16, 2013

CBOE OPTIONS INSTITUTE 2

Disclosure

Options involve risks and are not suitable for all investors. Prior to buying or selling an option, an investor must receive a copy of Characteristics and Risks of Standardized Options. Copies are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing Corporation at www.theocc.com. The information in this presentation is provided solely for general education and information purposes. No statement within this presentation should be construed as a recommendation to buy or sell a security or to provide investment advice. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in this presentation. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult with their tax advisors to determine how the profit and loss on any particular option strategy will be taxed. Past performance does not guarantee future results. Supporting documentation for any claims, comparisons, statistics or other technical data in this presentation is available from CBOE upon request.

CBOE, Chicago Board Options Exchange and VIX are registered trademarks and SPX, The Options Institute and Execute Success are service marks of Chicago Board Options Exchange, Incorporated (CBOE). S&P 500® is a registered trademark of Standard & Poor's Financial Services, LLC and has been licensed for use by CBOE. CBOE is not affiliated with Interactive Brokers. This presentation should not be construed as an endorsement or an indication by CBOE of the value of any non-CBOE product or service described in this presentation.

Copyright © 2013 CBOE. All rights reserved


Implied Volatility

Outline

Option Pricing Factors Review of Pricing FactorsGreeks ReviewFocus on Vega

What Implied Volatility is SayingWhat Implied Volatility is Not SayingBehavior of Implied Volatility


Option Pricing Factors

Review

Underlying Market PriceOption Strike PriceTime to Expiration Dividends Interest RatesImplied Volatility

Underlying, Time, and Volatilityare the factors that will change



Pricing Calculator

InputsPrice 51.00Strike 50.00Days to Exp. 30Dividends 1.95%Interest Rate 1.00%Volatility 25%

Where does this number come from?

Output Call PutTheo Price 1.90 1.10



Pricing Calculator

InputsPrice 51.00Strike 50.00Days to Exp. 30Dividends 1.95%Interest Rate 1.00%Call Price 2.00

Implied volatility is determined by themarket price of an option.

OutputVolatility 30%


What Implied Volatility is Saying

Projected Range

Bell Curve (you never get away from it) –

http://upload.wikimedia.org/wikipedia/commons/8/8c/Standard_deviation_diagram.svg�


What Implied Volatility is Saying

Projected Range

XYZ Stock at 100.001 Year XYZ 100 Call and Put Implied Volatility = 20%

Market Pricing with 68.2% CertaintyXYZ Between 80.00 and 120.00 in 1 Year

Market Pricing with 95.4% Certainty XYZ Between 60.00 and 140.00 in 1 Year

Market Pricing with 99.7% Certainty XYZ Between 40.00 and 160.00 in 1 Year


What Implied Volatility Is Saying

Projected Range

Implied volatility is an annualized number Using a simple formula this indicator can be ‘de-annualized’It may even be broken down to a single day move



Converting Implied Volatility

Formula –

Price x Implied Volatility x Square Root (Days / 365)

or

Price x Implied Volatility x Square Root (Days / 252)




XYZ at 70.00 30 Day XYZ 70 Call IV = 25%

70.00 x .25 x Square Root (30 / 365) = 5.01





70.00 x .25 x Square Root (21 / 252) = 5.05





70.00 x .25 x Square Root (3 / 365) = 1.58





70.00 x .25 x Square Root (3 / 252) = 1.90


What Implied Volatility Is Not Saying

Projected Path

Implied Volatility does not take into account the ‘path’ an instrument will takeIn reality traders monitor positions from day to day (or even on a shorter period of time) The reality is a bit different than the numbers show



Projected Path

We created a Monte Carlo Simulation to replicate random stock price movementsThis gave us data to show several trading paths over the ‘life’ of a tradeThe results were pretty interesting



Projected Path

Using Matlab we ran 1 million simulationsA variety of pricing and volatility inputs were usedThe results told us some interesting things about what happens during the life of a trade



Projected Path

Stock at $100Implied volatility of 30%Option expires 30 trading days out

Changing these parameters doesnot change the results.



Projected Path

Statistically (assuming the market is correct) a stock should close within up or down 1 standard deviation 68.2% of the time.

What percent of the time does a stock close outside 1 standard deviation during this 30 day period?

54.1%



Projected Path

What this means –

If you consistently initiated a trade based on implied volatility being correctly priced and you checked your account daily over a 30 day period over half of the trades would cause some concern.

This despite statistically ‘knowing’ the trade should work out 68.2% of the time.


What Implied Volatility in Not Saying

Summary

Implied volatility is considered a risk factor relative to the future price change of an underlying marketThe price of an option will move higher in anticipation of a large move in the underlying stock After an event such as earnings or another corporate announcement the stock will react and the implied volatility of an option will adjust to a historically normal level


Behavior of Implied Volatility

Overview

Different markets have varying price behaviorThis carries over to the implied volatility priced in by the respective option marketsNot all implied volatility is the same


10

20

30

40

1000

1250

1500

1750

Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13


Price Comparison

VIX vs. S&P 500 – Daily (Sep 2012 – Aug 2013)

Source: Bloomberg

S&P 500®

VIX®


0

25

50

75

100

125

150

175

200

0

250

500

750

1000

1250

1500

1750

2000200220042006200820102012


Price Comparison

VIX vs. S&P 500 – Weekly (Sep 2012 – Aug 2013)

Source: Bloomberg

S&P 500

VIX



Inverse Relationship

Jan 2000 – Aug 2013 S&P 500 Higher

VIX Lower

PercentOpposite

S&P 500 Lower

VIX Higher

Percent Opposite

2000 120 99 82.50% 132 105 79.55%2001 119 101 84.87% 129 95 73.64%2002 112 95 84.82% 140 110 78.57%2003 137 104 75.91% 114 84 73.68%2004 140 117 83.57% 112 86 76.79%2005 141 116 82.27% 111 89 80.18%2006 141 103 73.05% 110 82 74.55%2007 137 110 80.29% 114 94 82.46%2008 126 116 92.06% 126 109 86.51%2009 140 119 85.00% 112 83 74.11%2010 144 118 81.94% 108 87 80.56%2011 138 117 84.78% 114 90 78.95%2012 132 100 75.76% 118 91 77.12%2013 99 81 81.82% 69 54 78.26%Sum 1826 1496 81.93% 1609 1259 78.25%




10 Worst S&P 500 Days – Jan 2000 – Aug 2013Date SPX % VIX %

10/15/2008 -9.03% 25.61%12/1/2008 -8.93% 23.93%9/29/2008 -8.81% 34.48%10/9/2008 -7.62% 11.11%11/20/2008 -6.71% 8.89%

8/8/2011 -6.66% 50.00%11/19/2008 -6.12% 9.79%10/22/2008 -6.10% 31.14%4/14/2000 -5.83% 13.91%10/7/2008 -5.74% 3.13%


0

25

50

75

100

125

150

-65 -60 -55 -50 -45 -40 -35 -30 -25 -20 -15 -10 -5 0 5 10 15 20 25 30 35 40 45 50 55 60 65


Price Behavior

VIX Distribution of Returns – Jan 2007 – Aug 2013

74 15%+ Moves Since 2007

Source: Bloomberg




SPX Put / Call Ratio – Sep 2012 – Aug 2013

0.00

0.50

1.00

1.50

2.00

2.50

3.00


Source: Bloomberg



Mean Reversion

Implied volatility is a range bound measureAt times there may be some extreme movesBut generally Implied Volatility oscillates around a mean

In time…

A move up in VIX is usually followed by a drop

A long period of complacency in VIX will be followed by a spike


10

12

14

16

18

20

22

24



Mean Reversion

VIX vs. 10 Day Average – Sep 2012 – Aug 2013

10 DayAverage

VIX

Source: Bloomberg



Equity Volatility

Implied volatility is a forward-looking measure of market expectations When some sort of near-term catalyst is approaching, implied volatility as indicated by option pricing often increasesQuickly after the catalyst has come to fruition, implied volatility will drop to lower levels



Equity Volatility

Comparison with VIX (June 2010 – August 2013) –

Underlying CorrelationHigher Close

Volatility Lower

PercentOpposite

Lower Close

Volatility Higher

PercentOpposite

AAPL -0.4153 426 293 68.78% 393 247 62.85%AMZN -0.3410 419 256 61.10% 395 245 62.03%GOOG -0.4119 428 279 65.19% 391 261 66.75%GS -0.6290 419 312 74.46% 400 268 67.00%IBM -0.5597 430 308 71.63% 388 285 73.45%SPX -0.8115 453 364 80.35% 366 288 78.69%



Equity Volatility

GOOG I-Volatility Chart



Non-Equity Market Volatility

The implied volatility of non-equity related markets may have unique characteristicsCommodity volatilities differ from market to market



CBOE Gold ETF Volatility Index

Measures the market’s expectation of 30-day volatility of gold pricesThe VIX methodology is applied to options on the SPDR Gold Shares ETF (GLD)The index is quoted with the symbol GVZ and there are both options and futures trading on the index



Relationship to Market

GLD vs. GVZ – January 2013 – August 2013

10

20

30

40

50

60

50

75

100

125

150

175

Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13

GLD

GVZ

Source: Bloomberg



Gold Volatility Relationship to Gold Market

GLD vs. GVZ – 2008* – 2013* Statistics by Year

YearGLD High

GLD Low Range

GVZ High

GVZ Low

GVZ Average

2008* 96.17 70.00 0.37 64.53 22.69 38.792009 119.18 79.79 0.49 43.09 17.46 27.292010 139.11 104.04 0.34 30.73 16.23 20.912011 184.59 127.93 0.44 39.95 14.72 22.272012 173.61 149.46 0.16 25.36 11.97 18.142013* 163.67 115.94 0.41 34.48 12.07 20.08



Relationship to Market

GLD vs. GVZ – Correlation by Year – 2008* – 2013*

Year CorrelationGLD

Performance2008* 0.0213 -0.42%2009 0.3092 21.53%2010 -0.1023 25.67%2011 -0.1451 9.14%2012 -0.1289 6.39%2013* -0.7584 -18.53%



Summary

The implied volatility of equity index markets is very reactionary relative to what is going on in the underlying marketFor individual stocks, the behavior of volatility varies from stock to stock, but is usually anticipatoryOutside of equity-related markets, different markets have a variety of implied volatility activity


Introduction to Implied Volatility

Questions / Contact

More Questions?

[email protected] – @russellrhoads

Blog – www.cboe.com/blogs

mailto:[email protected]�

http://www.cboe.com/blogs�

interactive brokers webcast – october 16, 2013 ... · pdf fileimplied volatility is...

Documents