When markets collapse, pay attention to implied volatilities

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<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "We are always talking about implied volatilities in the options, mainly for the purpose of designing transactions that allow us to buy relatively cheap options and sell the relatively expensive ones, reversing the odds in our favor."data-reactid =" 22 "> We talk all the time about the implied volatility of the options, mainly in order to design transactions that allow us to buy relatively cheap options and sell the relatively expensive ones, by shifting the probabilities in our market.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "the CBOE (CBOE) The VIX index – a measure of the implied volatility of a basket of 30-day options on the S & P 500 – has fluctuated just above historical lows of about 10% in recent years, but recently climbed to mid-teens this year significant fluctuations in the level of the index and have reached the mid-twenties in the past two weeks, while markets have fallen."data-reactid =" 23 "> The CBOE (CBOE) The VIX Index – a measure of the implied volatility of a 30-day basket of options on the S & P 500 – has slightly exceeded the lowest 10% in recent years, but has recently climbed to Adolescents due to large is evolving at the index level and has reached the mid-twenties these past two weeks, while markets have fallen.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "To explain how stock movements translate (or, in some cases, do not seem to translate) into changes in the implied volatility of option prices, let us return to the concept of implied volatility."data-reactid =" 24 "> To explain how the movement of equities translates (or does not seem to translate in some cases) into changes in the implied volatility of option prices, let us return to the concept of implied volatility.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "There are hundreds or thousands of options on thousands of stocks, and the usual forces of supply and demand can not provide the cash needed for the markets to function properly. Most of the offers and options on the market come from market professionals. & nbsp; These market makers are willing to simultaneously provide bilateral quotes for many options in hopes of gaining the bid-ask spread on their transactions."data-reactid =" 25 "> There are hundreds or thousands of options listed on thousands of stocks.The normal forces of supply and demand can not provide liquidity As a result, most of the offers and offers of options the market is provided by professional market makers, who are willing to simultaneously provide double quotes in many options, in the hope of to obtain the bid-ask spread on their transactions.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Many market-making strategies are used at a given point in time, but in general, the market makers aim to be "Delta-neutral" – or to only expose themselves to the delta. little or no movement in the underlying stocks. & Nbsp;"data-reactid =" 26 "> Many market-making strategies are used at all times, but in general, market makers aim to be" neutral "- or not to be exposed to movements in the underlying stock.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Recall that the "delta" is the sensitivity of the price of an option to the evolution of the underlying. As they were simply trying to gain some of the spread and have no bullish or bearish opinion on the stock (and may even be at a disadvantage in terms of information relative to their counterparts in this regard), they would prefer to be agnostic on the direction in which the stock moves."data-reactid =" 27 "> Recall that the" delta "is the sensitivity of the price of an option to the movement of the underlying.Because they were just looking to earn some of the money. gap and have no bullish or bearish opinion on the stock (and in some cases, they may even be at a disadvantage in terms of information compared to their counterparts in this regard), they would prefer to be agnostic about to the direction in which the shares evolve.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Blanket"data-reactid =" 28 ">Blanket

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "After trading options, a market maker usually trades the underlying stocks in the opposite direction to mitigate the risks. & Nbsp; Known as "hedging", it involves acquiring or selling an equivalent number of shares to offset the total delta of option trading."data-reactid =" 29 "> After trading options, the market maker generally trades the underlying stocks in the opposite direction to mitigate the risks by buying or selling an equivalent number of shares. to offset the total delta trading options.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Example:"data-reactid =" 30 "> Example:

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "If a trader buys 10 prices with a strike price of 100 on a security that trades at $ 100, since the currency options have a delta of 0.50, the trader now has a delta of 500 – c 'ie in terms of price. this position will behave as if it were 500 shares long. If he was then to sell 500 shares, the position would be delta neutral. & Nbsp; For small movements of the stock, value that the options have earned, the position of the stock would be lost and vice versa."data-reactid =" 31 "> If an operator buys 10 calls with an exercise price of 100 on a security that is trading at $ 100, the options at the currency having a delta of 0.50, it has now from a delta of position 500 – that is to say in terms of price, this position will behave as if it was 500 shares long.She would then have to sell 500 stocks, the position would be neutral for the delta, any value the options have earned, the stock position would be lost and vice versa.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Note that this is only true for small movements. Why? we discussed the second Greek value: Gamma. & nbsp; Gamma is the delta sensitivity of an option to the movements of the underlying."data-reactid =" 32 "> Note that this is only true for small movements Why, because of the second Greek value discussed – Gamma Gamma is the sensitivity of the delta of an option to the movements of the sub- underlying.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Adjust the hedge"data-reactid =" 33 ">Adjust the hedge

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Suppose our example option above has a gamma of 0.01, which would mean that for every dollar spent on the underlying option, the option wins or loses 0 , 01 delta. & Nbsp; Therefore, if this stock were to fall to $ 90, the strike call of 100 would have a delta of only 40. & Nbsp; Since the trader still does not have 500 shares in stock, he only has more than 400 deltas of options (10 options * .40 delta) if he wants to remain neutral, he will have to buy 100 shares to balance his position. & nbsp; Since the initial hedge was created at a stock price of $ 100 and the adjustment of the hedge involves the repurchase of shares at the current market price of $ 90, it is Is a profitable business."data-reactid =" 34 "> Suppose that our example option above has a gamma of 0.01, which would mean that for every underlying dollar, the option wins or loses So, if this stock were to drop to $ 90, the 100 call would have a delta of only 40. The trader still has 500 stocks in stock, so he has only 400 deltas left in his possession. 39; options (10 calls * 0,40 delta) if he wants to be delta neutral, he will have to buy 100 shares to balance his positions because the initial hedge was created at a price of 100 USD and that the l 39; coverage adjustment involves the repurchase of shares at the current price of $ 90 in the market, it is a profitable business.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "If, later in the day, & nbsp; the stock had to rise back to $ 100, the trader would again need to adjust the hedge since the long calls would again be 50 delta and he would need to sell 100 shares to be neutral again."data-reactid =" 35 "> If the stock were to rise back to $ 100 later in the day, the trader would again need to adjust the coverage because the long calls would again be 50 delta and he needed to sell 100 shares to be neutral delta again.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Although the stock is now exactly in the same place as at the beginning of the day, the trader made a profit of 1,000 USD because he was able to cover the trade again at advantageous prices."data-reactid =" 36 "> Even if the stock is exactly in the same place as at the beginning of the day, the trader made a profit of 1,000 USD because he was able to re-cover the trade at competitive price.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "It would be the same if the stock rose to $ 110, then returned to $ 100, which allowed the trader to sell an additional 100 shares and buy them back down. & Nbsp; The movement in the stock is advantageous for a position that is long options – if covered – regardless of the direction of movement."data-reactid =" 37 "> It would be the same if the action went back to $ 110 and then returned to $ 100, allowing the trader to sell 100 more shares up and buy them down advantageous for a position that is long options – if covered – regardless of the direction of movement.

The story continues

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "The opposite would be true for a trader with the opposite position (10 short calls and 500 long shares) who undertook the opposite hedging transactions – a loss of $ 1,000."data-reactid =" 42 "> The opposite would be true for a trader with an opposite position (10 short calls and 500 long shares) having undertaken the opposite hedging transactions – a loss of $ 1,000.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Although the possession of options gives an operator the opportunity to hedge at profitable prices, remember that the third Greek that we talked about is Theta, a time-sensitive option that passes. & Nbsp; As time goes by, the trader's long options will have a lower value, whether or not they have made the hedging or re-hedging transactions profitable. & Nbsp; This effect will accelerate because the option will remain shorter until the option has a time value of zero and is worth the amount it is worth. is in the money, worthless."data-reactid =" 43 "> While the possession of options gives a trader the opportunity to hedge at profitable prices, remember that the third Greek we talked about is Theta – a sensitivity of the options As time goes on, the trader Long options are worth less, whether or not the hedging or re-hedging transactions are profitable, and this effect will accelerate as the option expires. unless it will eventually expire until the option has a time value of zero and is worth either the amount is in the money – or worthless.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Implicit vs. actual volatility"data-reactid =" 44 ">Implicit vs. actual volatility

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "How does the market achieve the implied volatilities used to value options? There is an effect of supply and demand in the workplace, as market managers sell options, they increase implied volatilities (and option prices) to try to buy them back and become flat again or again. sell more at a higher price. & Nbsp; The opposite occurs when market managers buy options."data-reactid =" 45 "> How does the market calculate the implied volatilities used to value options? There is an effect of supply and demand in the workplace as market managers sell In the case of options, they increase the implied volatilities (and option prices) in an attempt to either buy them back and become flat again or sell more at a higher price, while market makers buy options.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "The fluctuation of the underlying determines whether the options represent an opportunity for profitable hedging. & Nbsp; More movement in the underlying stocks means more opportunities for hedging and leads to higher option values. The fact that the implied volatility corresponds to the volatility observed depends on the period of time used to make the observation."data-reactid =" 46 "> The movement in the underlying determines whether or not the options represent an opportunity for profitable hedging operations.More movement in the underlying stock means more than enough. Opportunities for hedging and leads to higher option values.If implied volatility matches the volatility depends on the time period used to perform the observation.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "In the example above, if the volatility observed was measured daily on the basis of closing prices, it would be zero, because the stock closed at the same price as the one it had closed the day before. & Nbsp; However, intra-day volatility was much higher, allowing profitable re-hedging operations. & Nbsp; This would likely maintain implied volatility at a high level as it is beneficial for market makers to own options."data-reactid =" 47 "> In the example above, if the observed volatility was measured daily on the basis of closing prices, the measure would be zero, since the security closed on the same price as It had closed the day before, but intraday volatility was much higher, allowing for profitable re-hedging, which would likely keep implied volatility high, as it is advantageous for market makers to hold options.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Volatility also increases rapidly as the market declines. Markets tend to fall faster than they go up. A slowdown is thus hoping for larger movements. "Data-reactid =" 48 "> Volatility also increases rapidly when the market is down.The markets tend to fall faster than they do, resulting in higher expectations.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "But implicit flights tend to lag behind the real movement of the market, that is, they go up the highest. after the greatest movement has already taken place."data-reactid =" 49 "> But the implicit flights tend to be lagging behind the real market movement, ie they go up the highest after the greatest movement has already taken place.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Use higher implied volatilities"data-reactid =" 50 ">Use higher implied volatilities

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Since the beginning of the year 2018, this phenomenon has lasted 10 months. & Nbsp; The S & P 500 has hardly changed since the year but there have been huge movements in the index and in many individual stocks. & Nbsp; Each bearish move was accompanied by a spike in implied option theft. As a result, these implied volumes are now higher than they have been for many years."data-reactid =" 51 "> Since the beginning of the year, the phenomenon has lasted 10 months since the beginning of the year.The S & P 500 has hardly changed since a year. year, but significant movements have been recorded in the index and in many individual stocks, accompanied by a spike in implied option volumes, which are now higher than they are. had been for several years.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Implied volumes tend to follow a pattern of "what goes up should fall". When they are high, it is expensive for market makers to own options unless the underlying stocks move a lot – giving them renewable hedging opportunities. Once inventory movements have calmed down, option prices tend to fall rapidly."data-reactid =" 52 "> Implicit flights tend to follow the pattern:" what goes up should go down. "When they are high, market makers need to own options unless the underlying stocks They do not move much – giving them back Once the movement of stocks has calmed down, option prices tend to fall rapidly.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "This means that a conservative option selling strategy such as selling covered calls (selling money for stocks you already own) makes more sense now that the chests are high. & Nbsp; When implied volatilities are high, savvy investors can improve the performance of their portfolios by selling long-dated stock options at higher volatilities (and therefore higher prices) than they do. have been for a while. "data-reactid =" 53 "> This means that a conservative option selling strategy such as selling covered calls (selling money to shares you already own) ) makes more sense now that volumes are high.With high implied volatilities, savvy investors can improve the performance of their portfolios by selling calls against long stocks at higher volatilities (and therefore higher prices) than they have not been for a long time.

<p class = "canvas-atom canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "When markets find their way, the prices of these options will fall."data-reactid =" 54 "> When markets find their way, the prices of these options will fall.

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