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.