CHAPTER 3 - OPTION VOLATILITY STRATEGIES

Short Straddle

Short call option and a put option on the same underlying interest, with the same strike price and the same expiration date

VEGA

a measure of the sensitivity of an option's price to small changes in implied volatility.

In the case of a call time spread, when the long side of the spread is maintained after the short side expires , the reward is ? Risk is?

theoretically unlimited risk is limited to the net debit

WHEN TO USE Time spreads

underlying interest's price to remain around the strike price

SHORT COMBINATION

writing a call option and a put option on the same underlying interest with different strike prices

WHEN TO USE Short straddles

• When they feel that the underlying stock will remain at or very near the strike price (i.e., when actual volatility is low) • When they feel that the implied volatility of the options will decline • When they are willing to accept high risk in return for the premium received

time spread strategy maximum return is limited to

the market price of the long option less the spread's original debit.

There are at least two ways to determine whether the implied volatility of an option is considered high or low.

- Compare the option's implied volatility to the historical volatility of the underlying stock. - Compare the option's implied volatility to previous levels of implied volatility on the same contract.

WHEN TO USE Short combinations

When they feel that the underlying stock will remain between the two strike prices (i.e., when actual volatility is low) • When they feel that the implied volatility of the options will decline • When they are willing to accept high risk in return for the premium received

Historical volatility (sometimes referred to as statistical or realized volatility) is the

actual volatility exhibited by a stock over a defined period

future volatility is the

actual volatility that will occur during a period in the future

Vega is highest for ___________-money options and for options with several months remaining until expiration.

at-the

implied volatility is the

average forecast of future volatility by options market participants.

Long straddle

buying a call option and a put option

LONG COMBINATION

buying a call option and a put option on the same underlying interest, but with different strike prices.

time spread (also known as a calendar spread)

buying and writing an equal number of either puts or calls on the same underlying interest, with different expiration dates and the same strike price. To be eligible for spread margining, the long side must expire after the short side

volatility affects calls and puts

equally.

Estimates of a stock's volatility are typically formed by considering

historical volatility & both current and historical implied volatility.

Options traders often quote contracts in terms of

implied volatility levels

Long call and long put positions benefit from an ______________ in volatility.

increase

In the case of a put time spread, when the long side of the spread is maintained after the short side expires The reward is? The risk is?

limited to the strike price less the net debit originally paid. limited to the net debit paid.

Risk of the time spread strategy is limited to its net debit when

long side of the spread is liquidated at the time the short side expires or when the long side is exercised when the short side is assigned

LONG VOLATILITY STRATEGIES

long straddle, the long combination the time spread

investor would implement a bullish time spread if she feels that an underlying interest's price will ____________________ over the near term, but will _______ over the long term.

remain neutral rise

When an options trader has determined that a contract's implied volatility is abnormally high, the contract becomes a (buy/sell?) candidate

sell

SHORT VOLATILITY STRATEGIES

short straddle and the short combination

Historical volatility is measured by the__________________ and is almost always quoted as ______________________________

standard deviation of price returns an annualized value

Volatility is a

statistical measure of the amount by which the market price of a stock fluctuates during a given period

Time spreads are profitable when the underlying price _______________ the strike price, but they will also make money when implied volatility is ______________

stays close to increasing

Vega is typically expressed as

the change in option value caused by a 1% change in implied volatility.