Interesting takes on volatility in this week's Striking Price.
SINCE DERIVATIVE PRICES REFLECT the probabilities of potential outcomes, Striking Price commemorates the end of 2007 with a prediction for 2008.
After so much sturm und drang in the global markets in 2007, investors increasingly will view volatility as an asset that can be traded, just like stocks and bonds.
This view has long been touted by options pros, but now it's being bolstered by a Goldman Sachs research paper recently distributed to clients. In it, options strategists Maria Grant and Krag Gregory argue that stock volatility is an asset class, and that investors should commit money to it when they make asset-allocation decisions.
I guess that explains all the volatility-based products out these days. But there are issues.
One problem in viewing volatility as an asset class is that it's hard to model; data is scarce beyond the Chicago Board Options Exchange's Market Volatility Index (VIX). But Goldman has developed a "risk-equivalent portfolios" methodology that lets investors create volatility positions sized to meet specific targets.
Grant and Gregory say an asset class is defined by expectations that a passive position in it will produce significant returns above cash over time. Additional determinants include long-run returns that don't depend on investment skill, and diversification benefits in unfavorable markets.
Anyone with a basic understanding of options can benefit from volatility.
I never heard that asset-class definition before, but I'm all for skill not being a determinent of anything.
OK seriously, I think there's alot of truth to that last sentence, though I would tweak it a bit. A basic understanding of volatility can help any sort of trading. Even if you never touch an option. A successful day-trader for example has to have a sense of the volatility of the underlying product and adjust his stops and target prices accordingly.
While Goldman's research shows that sophisticated variance swaps generate the highest returns, basic options strategies also work well. Put selling and strangles selling beat call selling against stock, a strategy that has emerged as a mainstay in the options market.
Here's my beef with this. Put selling IS THE EXACT SAME THING as call selling vs. stock. A buy-write IS a put sale.
"Selling at-the-money straddles 12 times per year generated significant income, with an average monthly premium of 3.7%, resulting in 69% of months having a positive strategy return," Grant and Gregory write. However, selling 1% out-of-the-money strangles had the highest annualized return: 11.2%. Selling covered calls against stock produced the lowest risk-adjusted returns. The average monthly premium collected was about 1.9%, and the calls were exercised more than half the time
Sounds great. But it doesn't tell the whole picture. You could have a situation where monthly strangle and/or straddle sales work 7 times in a row, but then the 8th time is this past August and you get whipsawed out for a monster loss that eats up the first 7 month's relatively modest wins. All sorts of studies have shown that option selling works way more often than option buying. And personal experience would agree with that. The difference is the wins (losses) on net option buying (selling) tend to be quick and relatively large.
7 comments:
Steve Sears now "reporting" to pick up nickels in front of a steamroller (adam's 8th month). look, it works, but as an example, id rather sell a pbr jan 100/110 strangle and buy an april 100/110 aganst it than sell the jan alone. i mean talk about not being able to sleep at night..id rather be a long only "dummy" than have ALL short vol postions out there...quick question for adam---have you read charles cottle? he's the one that taught me yrs ago selling put/ selling cov call EXACTLY the same...not that hard, once you read it, but im not Goldman/Barron's...so...but at least im not a wind-chapped/pink-cheeked tom coughlin...what a little baby
Coach Genius Coughlin? Announcers had it backwards. If wind is so tough, then it should be major home field advantage. Theoretically they can practice in it a tad more than the road team. Annoying.
Yeah, I understand the pu equals buy-write thing isn't common knowledge. But a lot of it is BECAUSE they mistate it in articles like that. How couldn't someone be confused?
Absolutley agree with you on their last statement. My option trades tend to be net short calls or puts.But caution is waranted it isn't a free ride. Like whipping into a 10 lot of short es puts at the 1490 strike in after july expiration this year. If you didn't shor es or stop out you would have lost back months of profits.
yup, exactly. A theoretical mockup like that doesn't account for the whips in the middle. Even August if you just closed your eyes wouldn't have been a disaster in that it bounced back huge the last day and a half. But try watching that with short puts and not taking some action somewhere along the way. Not real likely.
Quote from jnbadger:
Please ask your broker the difference between a covered call and a naked put.
I'd love to hear what he has to say.
The broker:
"A covered call generates 2 commissions for me."
"A naked put only generates 1 commission."
"Thus, the covered call is a much better strategy."
-- freehouse [elitetrader]
I had never thought of it that way, but's that's a very interesting point. Naked put selling is always described as insane, while Buy-writing is like "income generation". For the broker.
In my opinion, this is just another way Wall Street can pick their customers' pockets.
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