Options Trading Strategies – Wrong Use of Historical Volatility and Implied Volatility Crossovers

March 5, 2011 by  
Filed under Option Trading

Options Trading Strategies – Wrong Use of Historical Volatility and Implied Volatility Crossovers

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Home Page > Finance > Investing > Options Trading Strategies – Wrong Use of Historical Volatility and Implied Volatility Crossovers

Options Trading Strategies – Wrong Use of Historical Volatility and Implied Volatility Crossovers

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Posted: Jun 27, 2009 | Views: 257 |

Not all volatilities are constructed equal.   It is critical to differentiate between Historical Volatility and Implied Volatility, so retail traders learn how to trade options focused on what is material to theoretically price option spreads forward. Historical Volatility (HV) measures past price movements of the underlying asset recording the asset’s actual or realized volatility.   The more commonly known type of HV is Statistical Volatility, which computes the underlying assets return over a finite but adjustable number of days.   Let me explain what “finite but adjustable” means.   You can vary the number of days to measure the Statistical Volatility: for example, 5-10-50-200 days, that’s how time-based moving averages and momentum/oscillator studies are built.   Though, it is not the case with Implied Volatility. Implied Volatility measures expected values by repetitively refining bid-ask estimates.   These estimates are based on the expectations of buyers and sellers. The buyers and sellers (85+% of floor traded volume is driven by institutions, floor traders and market makers) behind the bid and ask values, who do change their estimates within the day, as new information be it macro-economic news or micro-economic data impacting the underlying product becomes available.   What is being estimated is the underlying asset’s future fluctuation with certain assumptions embedded into the changes in information of the underlying.   That refinement of bid-ask estimates must be completed within finite time-bound option expiration periods. That’s why there are monthly and quarterly option expiration cycles. You cannot change these expiration periods, either by shortening or lengthening the number of days, to “construct” a time period that gives you faster or slower crossover indicators. Why point out the wrong use of Historical Volatility and Implied Volatiity Crossovers? It is to caution you against the defective use of  HV-IV crossovers, which is not a reliable trading signal.   Remember, for a given expiration month, there can only be one volatility over that specific period.   Implied Volatility must leave from where it is currently trading at, to converge at zero on expiration date. Implied Volatility (be it IV for ITM, ATM or OTM strikes) must return to zero on expiry; but, price can go anywhere (up, down or stay flat). To continually sell “overpriced” and buy “under priced” options would eventually cause the implied volatility of every single non-zero bid option to line up exactly.   Meaning the phenomenon of IV’s “smiling” skew disappears, as IV becomes perfectly flat. This hardly happens, especially in highly liquid products. Take for example, the SPY, a broad-based Index; or, GLD – the SPDR Shares ETF in a fast market like Gold. With open interest at the non-zero bid strikes going into the thousands and tens of thousands, do you really think a retail off the floor trader is going to be allowed to “out price” the professional hedger on the floor?  Unlikely. Calls and Puts in highly liquid products, are like items in an inventory with high supply because there is high demand.   This type of inventory does not get “mispriced” because floor traders have to make a daily living from trading the Calls and Puts –they will refuse to carry the risk of mispricing overnight. So, what are the key considerations to banking in your edge as a retail trader? IV’s percentage impact on an option’s extrinsic value is much more sizeable for ATM and OTM strikes, versus ITM strikes which are laden with intrinsic value but lack extrinsic value.   Most retail option traders with an account size USD $25-$50K (or less), gravitate towards ATM and OTM strikes for reasons of affordability. The deeper the ITM you go, the wider the Bid-Ask spread becomes compared to the narrower Bid-Ask spread differences in the ATM or OTM strikes, making ITM strikes more costly to trade. When you trade IV, you are buying time decay for a rise in IV at a % point below; or, selling time premium for a drop in IV at a % point above the theoretical price of market value, that participants are willing to pay or sell for.   Depending on the market ranges of that day, price debit spreads to get filled at 0. 10-0. 15 below the Theoretical Price of the spread.   With credit spreads, raise the credit to sell the spread by 0. 10-0. 15 above the Theoretical Price of the spread.   The price you pay below; or, receive above the Theoretical Price of a spread is your edge, purely based on price-performance of Implied Volatility alone. Remember, you Theoretically Price a spread to fill the order for its forward value, never backward. Where can I learn how to trade options with consistent profits focused on Implied Volatility without Historical Volatility? Follow the link below, entitled “Consistent Results” to see a model retail option trader’s portfolio that excludes the use of HV and focuses on trading only IV. I’ll cite these actual historical events, to bolster the argument for removing Historical Volatility from your trading process altogether. 27 Feb, 2007: Widespread Panic from the sizeable China sell-off in equities. If you were trading the options of an index like the FXI which is the iShares product of China’s 25 largest and most liquid Chinese companies though listed in the US; but they are headquartered in China, you would have been impacted. While you can argue it’s possible to have market events recreate the ranges of the Dow, Nasdaq & S&P, how do you recreate the scenario of the VIX and VXN soaring 59% and 39%?22Jan, 2008: Fed cuts rates by 75 basis points prior to the scheduled policy meeting on Jan 30th, whereby the FOMC cut another 50 basis points on the date of the meeting.   If you were trading interest-rate sensitive sectors using the options on a Financial ETF or a Banking Index like the BKX; or, the Housing Index like the HGX, you would have been impacted. And in the current environment of rates being near zero, the FOMC while they still have a rate policy tool, they are unable to cut rates by the same number of basis points like before. What was a historical event is not successively repeatable going forward, not until rates are raised again and subsequently they get cut again. Question: How do you reconstruct history?  That is the history of events forming Historical Volatility.   The answer is in the real examples cited, as with any other financially related historical event – you cannot reconstruct history. You may be able to mimic parts of HV but you cannot repeat it in its entirety.   So, if you continue using HV-IV crossovers, you visually confuse yourself by searching for volatility “mispricing” patterns that you would like to see; but, you will end up with poor profit performance instead.   It makes more practical trading sense to focus purely on IV; then, diversify the trading of volatilities across multiple asset classes beyond equities. Where can I learn more about trading IV across multiple asset classes using only options, without having to own stock? Follow the link below (video-based course), that uses IV Mean Reversion/Mean Repulsion and IV Forecasting, as reliable methods to trade the implied volatilities across broad-based Equity Indexes, Commodity ETFs, Currency ETFs and Emerging Market ETFs.

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Clinton Lee –
About the Author:Please see Consistent Results http://www. homeoptionstrading. com/consistent_results/.
Here’s the summary for month-end July 2009 . . .
❑ Return: Profit/Start of Year Cash Balance = UP +115%! That’s +16. 43% Return per Month!
❑ Win/Loss Probability = 90. 20%. 9 Wins per 1 Loss. Average Win/Average Loss = $3. 66 Won per $1 Loss.
❑ Performance Ratio = (Win/Loss Probability) x (Average Win/Average Loss) = 90. 20% x $3. 66 = 3. 30.
❑ Positive Expectancy = $1,316 per trade.

Preview an original 55 hour video-based course for online options trading from home, at http://www. homeoptionstrading. com/original_curriculum. html
Purchase the curriculum and receive a $800 options basic course as a Bonus!

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Hi, Im looking for historical and implied volatility data on commodity options and was wondering if you know of any free websites that provide this info?
I am having more clients who are interesting to invest money in private placement program in INDIA. Please suggest me the best option for bullet trading. Dr. V. B. Rao Dasari drvbraodasari@gmail. com
What is the best approach to use forex signal in forex trading? Is this driven by fundamental aspect of trading?

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Article Tags:
stock option trading, options trading strategies, how to trade options, implied volatility, historical volatility, volatility

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Please see http://www consistent results. homeoptionstrading. com / consistent_results /. Here? est? summary of month-end July 2009. . .????? Return: Income / Starting cash balance = 115% UP! That is 16. 43% Return per month !????? Win / Loss Probability = 90. 20%. 9 wins by a p? Loss. Average Win / Loss M = $ 3. 66 won by the p? Loss of $ 1 .????? Performance Ratio = (Win / probability of p? Loss) x (Win Media / P? Average loss) = 90. 20% x $ 3. 66 = 3. 30 .????? Positive expectation = 1,316 d? Dollars per OPERATION? N.Vista after an original course of 55 hours of v? Deo based on options trading in l? Line from home, at http://www. homeoptionstrading. com / original_curriculum. htmlCompra curriculum and receive a $ 800 course options b? musician as a bonus!

Best Forex Practice Account – Do This Wrong and You Will Mess Up Your Trading

July 29, 2010 by  
Filed under Forex Trading

Best Forex Practice Account What if I said a forex practice account can be extremely damaging to your business life? If you’ve read any of my publications, you’ll know that I am a big fan of using fake money to play and practice software testing. However, if done incorrectly, wish it had never registered in one of these tools libres.Probablemente you are wondering why a forex practice account I cause any harm? It’s free. I can trade away all day and not lose a centavo.En First, if you’ve never heard of a practice account, is exactly what it sounds. It is identical to real trading account unless you have “play” money in it. You can test trading methods without risking your cash de.Muchos runners allowed to have one for free. Reason companies do this is just expect them to deposit money with them in a real account at some point in the futuro.Así here’s the problem. If you asked any full-time trader making it one of the biggest obstacles they often hear “emotions.” It’s amazing how emotional you can get when money is on the line. You are seeing prices rise and fall and his emotions go along with every tick of the price soon. Using fake money does not help get your emotions going. Best Practice Account ForexLa people tend to be very casual and careless openness to trade using fake money. They trade with large sums of money. If things go wrong, no big deal. You can even say that would not have done that if it was real money. Trust me on this, this happens all too frecuencia.Las emotions must be under control. Full-time, professional traders are very quiet, no matter if win or lose money. They know it’s just a game of numbers and losses are part of acuerdo.Creo in using these as a tool to help you become a better trader. It is a necessary step to take. However, it is necessary to treat it as real money. Get yourself into a mental state that money is real. Take it slow as you would with real money. Do not worry if you make losses. Do not get excited about winning trades. Follow your trading strategy to carta.Si you are using or planning to use automated trading software like me, use your forex practice account to test the software. Set up as instructed by the software company. Although not as critical of manual trading, be sure to configure and use it as you would with cash real.No mistake about it, use a Forex practice account the right way, and for software testing go a long way to a profitable forex trader! Best Forex Practice Account

Always dream of being Rich? Never able to make a Consistent Profit through trading?Get your Best Forex Practice Account and be Successful forever!Try this Surefire Forex Challenge and be Financial Free in 6 Months!

Forex Trading Gone Wrong – 4 Warning Signs About Your Currency Trading

July 26, 2010 by  
Filed under Currency

Many people out there are constantly searching for a forex trading system which can generate profits everyday for them, are you doing the same thing too? I assume that you might have seen articles on why 95% of the traders lost money in the currency market, so I won’t go into that anymore. What I would want to emphasize below is the 4 warning signs about currency trading which prevent them from being successful. #1 – Trading systems must be sophiscated Since technology is so advanced in a world like ours today, traders always think that the more complicated and difficult is a trading system, the better and higher the success will be. This is definitely not true. For the past few years, I have seen traders maintaining their trading career for more than 10 years by just using some of the simple forex trading strategies. This is because in a brutal ever changing currency market, simple systems work best as they are more robust. #2 – Working hard like any other businesses I will always agree that massive hard work that you have put in for other jobs or businesses will reward you in long term, but not for forex trading. Isn’t it amazing to know that you can be a successful trader without having to work hard? Instead you need to work smart. Follow the rules of your proven forex strategy and the market will reward you eventually, you do not have to keep on looking for trading opportunities every minute or so. #3 – Keeping ego and afraid of losing If you are a forex trader who does not have any losses, then probably you are not trading at all. I have to admit that I hate to loose in the past too, but once I know that I can profit consistently from the market even there were some small losses, I accepted the fact. Even the best trader of all time does not have a 100% winning rate, and no one does because the market will never allow that. #4 – Forex scalping gives fastest profits I can’t stress this much enough that you should be looking for quality trades rather than quantity. In the past few years, I have experimented all sorts of forex trading techniques and I can only say that scalping is a very difficult strategy for me. I can turn any of my forex day trading signals into nice profits but not from scalping, as it is not my style of trading. I have a question for you here. Would you rather earn 300 pips with just 3 trades in a month or would you stress yourself out by looking for 10 pips everyday? If you chose the latter, I must let you know that currency trading is all about high probability trades. I can assure that you won’t find quality trades everyday, and since that is the case, you could end up losing much more than what you have scalped from the market. The above forex tips are something you must learn before you can embark on your trading career with more confidence. My personal advice to you is to first master your trading skills with a proven forex trading system and with some money management and discipline, you are almost ready to be start a home business earning consistent profits from forex trading.

To learn how to trade forex successfully using a simple, time-tested and proven forex trading system, download my FREE 56-page “Forex Trading To Riches” ebook at http://www. forextradingpower. com.
The author, Daniel Su, is the owner of http://www. ForexTradingPower. com where you can get free premium forex trading tips and resources. Daniel Su specializes in teaching real people how to trade the Forex market for long term financial success.

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