4 ms·

Be careful with volatility. I don't know what he's trading on exactly. But a big part of volatility trading is selling insurance, i.e. selling insurance again

by ww520 9y ago

Be careful with volatility. I don't know what he's trading on exactly. But a big part of volatility trading is selling insurance, i.e. selling insurance against the direction of S&P. You can make a lot of money collecting insurance premium, but on the event of a payout, like a sudden big drop in S&P, the loss can be very substantial. See XIV and SVXY in February of this year.

nostromo 9y ago
Trading volatility might imply that he's buying options in both directions. Big moves either up or down would be profitable. The only unprofitable move here would be no substantial moves in either direction. (In which case you lose your entire bet, but no more.)
- pranitbauva1997 9y ago
  The common strategies are delta heding, gamma hedging and gamma scalping for market neutral trades.
- kgwgk 9y ago
  > Big moves either up or down would be profitable. The problem is that much more often than not the “only unprofitable move” is the one that happens. Options in general are too expensive and that’s why selling “insurance” is profitable most of the time. Maybe he can identify consistently mispriced vol, though.
  - thrwyaltdata 9y ago
    > Maybe he can identify consistently mispriced vol, though. This was the method I used, as described in another comment.
    - kgwgk 9y ago
      Very interesting, thanks for the pointer.
- e12e 9y ago
  Could you expand on how that would work? If X is priced at 10 units of currency, and I promise to buy 1 X for 11, and to sell 1 X for 9. And X stays available for 10, I end up paying 11, receiving 9 - netting a loss of 2. If I manage to promise a sell/buy at 10, I even out. What do I lose with low volatility? And how do I make money "both ways"? Clearly I lack a basic understanding of the concepts involved.
  - skolos 9y ago
    In volatility trading you don't cary naked options (you hedge them usually dynamicaly - readjusting hedge every now and then) and usually close positions before options expire. So your analysis does not apply. If you want to get understanding on how to trade volatility the "Volatility Trading" by Euan Sinclair is excelent.
  - philipodonnell 9y ago
    "Volatility" in the term "Volatility Trading" does not mean the stock's movements, it is a way of measuring the excess value in an option beyond what the parameters of the option would imply. That excess value is usually referred to as the market's assumption about the future volatility of the stock, but really its just an error term influenced by market participants based on supply and demand. Low volatility means "pretty close to its theoretical value assuming no volatility" or to put it another way: "cheap" i.e. good for buyers and bad for sellers. Sort of like how different companies with the same cash flows can trade at different multiples, otherwise identical options in two companies (or different expirations/strikes in the same company) can trade at different prices because of the opinions of market participants. Volatility traders act when the different prices/error terms are too far apart, counting on the prices/error terms to converge a.l.a. pairs trading. Since they are trading the error term directly, they attempt to construct positions that remain relatively flat in value as the stock moves around, but are designed to only change in value when the error term changes. That is how they can make money "both ways", because they can profit if the stock goes up, down, or stays the same, as long as the error term moves in the correct direction. The reason you only see sophisticated people doing this kind of trading is because you need a large and complex position with many hundreds of options to be in a truly market-neutral environment. You can't take advantage of mispricing without such a large position because buying/selling single options involves a tremendous amount of risk, so you need to do that as a part of a larger portfolio to spread that risk. Retail traders tend to spread the risk by doing 2 transactions (the mispriced option and a well-priced but mirrored hedge option), but that is a) much more expensive from a commissions standpoint and b) really limits the range of market-neutrality forcing you to adjust more frequently to stay market-neutral, again, with commission costs.
aaavl2821 9y ago
if you delta hedge (ie taking opposing positions in the underlying and the derivative, ie selling a call and buying the stock and then constantly readjusting your position), you can protect yourself against small / normal changes in price of the underlying, but if there are big jumps in the underlying, and acceleration of delta (ie gamma) you can lose a lot.
thrwyaltdata 9y ago
On a per equity basis there are reasonably consistent ways to predict near term volatility using sentiment analysis and revenue forecasting ("alternative" data). I would not attempt this with something like the VIX, but for selling options on individual equities it can work.

by ww520 9y ago

nostromo 9y ago

Trading volatility might imply that he's buying options in both directions. Big moves either up or down would be profitable. The only unprofitable move here would be no substantial moves in either direction. (In which case you lose your entire bet, but no more.)

pranitbauva1997 9y ago
The common strategies are delta heding, gamma hedging and gamma scalping for market neutral trades.
kgwgk 9y ago
> Big moves either up or down would be profitable. The problem is that much more often than not the “only unprofitable move” is the one that happens. Options in general are too expensive and that’s why selling “insurance” is profitable most of the time. Maybe he can identify consistently mispriced vol, though.
- thrwyaltdata 9y ago
  > Maybe he can identify consistently mispriced vol, though. This was the method I used, as described in another comment.
  - kgwgk 9y ago
    Very interesting, thanks for the pointer.
e12e 9y ago
Could you expand on how that would work? If X is priced at 10 units of currency, and I promise to buy 1 X for 11, and to sell 1 X for 9. And X stays available for 10, I end up paying 11, receiving 9 - netting a loss of 2. If I manage to promise a sell/buy at 10, I even out. What do I lose with low volatility? And how do I make money "both ways"? Clearly I lack a basic understanding of the concepts involved.
- skolos 9y ago
  In volatility trading you don't cary naked options (you hedge them usually dynamicaly - readjusting hedge every now and then) and usually close positions before options expire. So your analysis does not apply. If you want to get understanding on how to trade volatility the "Volatility Trading" by Euan Sinclair is excelent.
- philipodonnell 9y ago
  "Volatility" in the term "Volatility Trading" does not mean the stock's movements, it is a way of measuring the excess value in an option beyond what the parameters of the option would imply. That excess value is usually referred to as the market's assumption about the future volatility of the stock, but really its just an error term influenced by market participants based on supply and demand. Low volatility means "pretty close to its theoretical value assuming no volatility" or to put it another way: "cheap" i.e. good for buyers and bad for sellers. Sort of like how different companies with the same cash flows can trade at different multiples, otherwise identical options in two companies (or different expirations/strikes in the same company) can trade at different prices because of the opinions of market participants. Volatility traders act when the different prices/error terms are too far apart, counting on the prices/error terms to converge a.l.a. pairs trading. Since they are trading the error term directly, they attempt to construct positions that remain relatively flat in value as the stock moves around, but are designed to only change in value when the error term changes. That is how they can make money "both ways", because they can profit if the stock goes up, down, or stays the same, as long as the error term moves in the correct direction. The reason you only see sophisticated people doing this kind of trading is because you need a large and complex position with many hundreds of options to be in a truly market-neutral environment. You can't take advantage of mispricing without such a large position because buying/selling single options involves a tremendous amount of risk, so you need to do that as a part of a larger portfolio to spread that risk. Retail traders tend to spread the risk by doing 2 transactions (the mispriced option and a well-priced but mirrored hedge option), but that is a) much more expensive from a commissions standpoint and b) really limits the range of market-neutrality forcing you to adjust more frequently to stay market-neutral, again, with commission costs.

aaavl2821 9y ago

if you delta hedge (ie taking opposing positions in the underlying and the derivative, ie selling a call and buying the stock and then constantly readjusting your position), you can protect yourself against small / normal changes in price of the underlying, but if there are big jumps in the underlying, and acceleration of delta (ie gamma) you can lose a lot.

thrwyaltdata 9y ago

On a per equity basis there are reasonably consistent ways to predict near term volatility using sentiment analysis and revenue forecasting ("alternative" data). I would not attempt this with something like the VIX, but for selling options on individual equities it can work.