# Oz Options-Volatility Analysis



## wayneL (28 February 2006)

Hi folks,

As part of easing into Aussie options I want to go through some of the things I looked at with US options. Analyze some stocks and collectively put on some dummy trades....hopefully to everyones benefit.

The Oz options market is different and I am going through a brand new learning curve.

So what I want to do is put in my $0.02 and see what you all think, and you can put in your $0.02 and see what come out.

***************
I'll explain a few things for non option traders and make it basic so the most people can follow along, but I'll presume at least some knowledge.

I'm a firm believer in considering volatility first before considering the strategy, whether directional or not.

So what is volatility? Volatility is simply how much an instrument (stock in this case) bounces around in the market path.

In the options market their are two types of volatility:

1/ Statistical or Historical Volatility (SV) - This is the actual measured volatilty over a specific time frame in the immediate past.

2/ Implied Volitility (IV)- Is the markets view of the possible volatility in the immediate future. Basically it's a guess.

SV looks back, Iv looks forward.

How is it measured? 

SV is measured in various ways (standard deviation, Average true range etc) but option SV is measured in a specific way. The lookback period is usually 20 trading days and expressed as an anualized percentage. The metamumble (or amibroker) equation is:

(Stdev(Log(C/Ref(C,-1)),20) * Sqrt(252))*100

IV is an input into the "Black Scholes Option Pricing Model" (or similar) and is used as an input to create a price for an option (along with price of underlying, strike, expiry etc), or it is reverse calculated using algebra, when a price in the market place has already been set by supply and demand.


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*

Lets look at a chart of statistical Volatility on CBA.

The current value is 9.86%, but the obvious thing here is that it tends to oscilate from as low as 7% to around 20% in this time. That tells us something already and may be useful in trading. But more on that later.

Each instrument will have its own range of values depending on the native volatility of that stock. Biotechs will tend to have higher values, whereas mature industrials will have lowre values. This is important to note as it will affect IV and the greeks and must be considered before any strategy is considered.


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*

Now lets have a look at the chart of Implied Volatility.

The current value is in fact 12.84%. The first thing you will notice is that this Implied Volatility is different from the actual statistical volatility (another important note)... and in the same time period has varied between 11.75% and 15.25%


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*

Now for the last post this evening, this is the two volatility types plotted together. You should notice some things immediately... have a look and we'll get into it tommorrow or whenever...I'm off to bed :goodnight


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## ducati916 (28 February 2006)

*Re: Trading Aussie Options*

*WayneL* 



> As part of easing into Aussie options I want to go through some of the things I looked at with US options. Analyze some stocks and collectively put on some dummy trades....hopefully to everyones benefit.




Agreed, placing of actual, or paper trades is always a good idea.
Successful Options traders, if you believe the press, are even less common than successful stock traders.



> IV is an input into the "Black Scholes Option Pricing Model" (or similar) and is used as an input to create a price for an option (along with price of underlying, strike, expiry etc), or it is reverse calculated using algebra, when a price in the market place has already been set by supply and demand.




I thought Black-Scholes was long gone, and had been superceded by Tri-nominal trees due to the failure of Brownian theory.



> 2/ Implied Volitility (IV)- Is the markets view of the possible volatility in the immediate future. Basically it's a guess.




Interesting, but I thought technical analysis, via determinism, contained valid theory regarding the analysis of market information contained in, price, volume, and volatility.

jog on
d998


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*



			
				ducati916 said:
			
		

> *WayneL*
> I thought Black-Scholes was long gone, and had been superceded by Tri-nominal trees due to the failure of Brownian theory.




It's true that a body of work has been done on option pricing since Black and Scholes. It is however still the industry standard, particularly for european style options. The other standard is the cox-rubinstein binomial, and as you mention there are others. These industry standards do not account for leptokurtic distribution, hence the volatility smile...a more advance concept we can get into later.

All contain more complexity than I am interested in exploring, and all I can say is thank God for third party spreadsheets. But as a a trader I don't need to know the intricacies of each model; there are only profound differences when close to expiry, as I understand.

Black Scholes still gives us a workable model, for all intents and purposes.

http://www.asx.com.au/investor/options/getting_started/pricing_models.htm



			
				ducati916 said:
			
		

> Interesting, but I thought technical analysis, via determinism, contained valid theory regarding the analysis of market information contained in, price, volume, and volatility.




I don't quite know where you're going with this one but I'll try....

As I've really tried to convey on a number of occasions, I don't view TA as deterministic at all. I've always viewed it at recognising chaos. The options market, as far as I see it, obviously views the market as chaotic as we see this in the IV's of certain stocks, and nearly all stocks at certain times.

But I want to purposefully avoid TA and FA in this thread and instead, stick to "views" of price movement, no matter how they are derived.

Cheers


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## dutchie (28 February 2006)

*Re: Trading Aussie Options*

WayneL

This thread looks interesting (and educational). Keep it up, mate.

Keeping it simple (for us simple folks) is great. 

I agree that discussing the pro's and con's of TA & FA should be left to another thread.


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*

The next step in analysing volatility is threefold.

1/Comparing IV to SV

2/Determining the "relative" level of IV and coming to a view of the immediate future of IV (whether it is going to go down or up)

3/Considering the "absolute" level of IV

What we are trying to arrive at here, is whether we should be trying to sell options, buy options, or spread.

So lets go ahead and have a look at our CBA volatilities.

1/Comparing IV to SV: The first thing I notice is that apart from the SV spike in aug-sept (this caused by a gap in the market, and apart from the direct consequeces of the actual gap, can be considered artifact) is that IV is consistently higher than SV.

So what does that mean? It means that CBA optiuons are always priced just a bit higher than is warranted by the actual volatility of price movement. In other words, they are more expensive than they should be. This puts the option buyer at a disadvantage. So with this piece of the jigsaw puzzle, we should be leaning towards selling or spreading

2/Determining the "relative" level of IV and coming to a view of the immediate future of IV: We see that IV is actually at a lowish point in it's IV range, not having spent time at this low a level for nearly six months. This means that CBA options are probably at/or nearly as cheap as they are going to get.

This little part of the jigsaw puzzle says that buying could be an appropriate strategy and therefore long vega. Particularly if we believe that IV will revert to the higher levels it has been at recently. But beware IV could go lower and linger at a low level for a while. That's why we need a view of where IV could be going. We look to SV for this. Are we expecting the stock to become more volatile, less volatile or about the same?

3/Considering the "absolute" level of IV - We wnt to look at this because it's important in consideration of the greeks. This part of the puzzle will further determine our buy/sell/spread bias.

Let's face it. CBA is a relatively low volatilty stock. 12-13% (even if it is higher than the SV) is pretty low. This means we will have higher gamma than a higher vol stock and also lower theta (time decay) This is going to favour buying, and certain spreads over others.

Lastly we want to consider how this all fits in with our view of the share price.

My opinion is if your view is directional and expecting a decent move, buy puts or calls, or possibly backspreads.

I would not recomend straddles/gamma trading because of IV being > SV...unless you believe a strong move is imminent.

If not expecting movement then a short strangle/long butterfly or condor would be entirely appropriate...so long as there is a willingness to defend the position.

I don't have a view of how I'd trade this atm but just using this as a random chart to show how I analyze volatilty.

Cheers


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## sails (28 February 2006)

*Re: Trading Aussie Options*

Great thread Wayne - also just wondering which charts you are using to get IV and SV superimposed?

I've found the banks are pretty good for short term directional plays just with long puts or calls - the big 4 all seem to have chronically low IV except around earnings or fast moves.  WOW is another one and NWS is currently on the lower end of the IV scale.


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*



			
				sails said:
			
		

> Great thread Wayne - also just wondering which charts you are using to get IV and SV superimposed?
> 
> I've found the banks are pretty good for short term directional plays just with long puts or calls - the big 4 all seem to have chronically low IV except around earnings or fast moves.  WOW is another one and NWS is currently on the lower end of the IV scale.




Margaret,

I am subscribing to www.premiumdata.net where you can opt for  "indicator" data....and plotting in Metacrock. This gives all the IV's plus  put/call ratio, a/d line etc.

NWS!!! (nervous laughter) It certainly elicites a certain anount of fear in my psyche. Usually managed to get whacked by it when it was NCP LOL


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## professor_frink (28 February 2006)

*Re: Trading Aussie Options*

hi there wayne,
                      interesting thread you've started here. quick question- why after all of this analysis,don't you have an opinion on how your going to trade options on this stock? Or are you waiting for the underlying to start making its move first?
not asking for a free recommendation or anything like that(made my play on cba yesterday  ),  was just after a bit more info on your thoughts on this one.

p.s happy to hear that I'm not the only one who cries like a girl when nws is mentioned


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## wayneL (28 February 2006)

*Re: Trading Aussie Options*



			
				professor_frink said:
			
		

> hi there wayne,
> interesting thread you've started here. quick question- why after all of this analysis,don't you have an opinion on how your going to trade options on this stock? Or are you waiting for the underlying to start making its move first?
> not asking for a free recommendation or anything like that(made my play on cba yesterday  ),  was just after a bit more info on your thoughts on this one.
> 
> p.s happy to hear that I'm not the only one who cries like a girl when nws is mentioned




heheheh

Re opinion on CBA

I don't want to really go into analysis on this thread, but my "view" is that it's fully priced and may linger around this level until march expiry. 

Quite willing to go into more detail in a separate thread


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## professor_frink (28 February 2006)

*Re: Trading Aussie Options*

ok thanks wayne. 
Hope you're not too right on that one  
I'm sitting pretty so I'm holding for a couple more days yet.
enjoy your afternoon.


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## wayneL (1 March 2006)

*Re: Trading Aussie Options*



			
				professor_frink said:
			
		

> ok thanks wayne.
> Hope you're not too right on that one
> I'm sitting pretty so I'm holding for a couple more days yet.
> enjoy your afternoon.




Professor, I don't have a position, so I hope I'm wrong and it goes well for you  

Further to Volatility on Oz stocks, I've noticed some decidedly different charactaristics between the two markets as far as IV is concerned.

I've finally got Metacrash stable with the template I'm using (Amibroker won't do what I want in this regard) so can now post up any chart. So if anyone wants a look at SV/IV plotted together on a particular stock just ask  

Back to IV: In the US IV's will basically track SV in most circumstances (apart from pre announcements and suchlike) If IV does vary from SV, it is more likely that IV will swing to wider extremes than SV.

I'm noticing the exact opposite here in Oz. IV's tend to be more stable not really tracking SV swings at all. A typical example is this chart of ANZ below...red line is SV, black line is IV. This is interesting and could be used to advantage.


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## wayneL (1 March 2006)

*Re: Trading Aussie Options*

Another feature is the chronic overvaluation of the options of some stocks, for instance NWS. IV's are constantly higher than SV's ... a lovely situation for writing options ... or better still short spreads.

This is going to be a great weapon to slay the NWS beast with.:whip

Just observations for now, but will post situations as they arise....


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## wayneL (1 March 2006)

Folks,

Here is an opportunity...NCM

IV is at it's highest level since at least Jan 2004 @ ~40-45%. SV is showing a spike on the chart but is due to a one off price move (announcement based) and  contains a deal of artifact. True SV would be about the same as IV.

So Here is an opportunity to sell some options.

Looking at the price chart, we have support at ~$21. The question is, will that hold and will POG, which is holding quite well, underpin this price. 

When writing options it it is more useful to determine where you think the price won't go, rather than where you think it will go....much easier analysis  

Now, because we have some recent volatility, and POG can really go anywhere, fast, there are unacceptable risks in writing naked options on this baby. Naked puts maybe if you don't mind ending up with the shares.

But I'm inclined more towards credit spreads. Because of the high absolute level of IV, we can get good risk reward charactaristics in a front month spread. An Iron Condor could even be the go.

Thoughts?

(PS I have changed the title of the thread)


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## professor_frink (1 March 2006)

here's my opinion wayne- sell the 19.50 and buy the 19. looking at the chart, the support level should hold(at least for awhile!), and with the overall market starting to look a bit toppy(maybe???) the 19.50 should allow enough room for it to play out, and allow you to sleep well(unless your me, then you never sleep well, even when holding cash)  

looks like you were right on cba- bailed out early this morning for a small gain. luckily I missed the bloodbath that is happening right now!


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## Bloveld (1 March 2006)

Hello
The IV that you have on the chart, how is it created?
Is it the average IV of all calls, or puts and calls, or the IV of just 1 series?
Is that metastock? If it is, how do you go getting the dates to line up in 2 different charts?
In Tradestation data can be charted in an indicator window on the 1 chart.
Thanks Steve


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## sails (1 March 2006)

*Re: Trading Aussie Options*



			
				wayneL said:
			
		

> Margaret,
> 
> I am subscribing to www.premiumdata.net where you can opt for  "indicator" data....and plotting in Metacrock. This gives all the IV's plus  put/call ratio, a/d line etc.
> 
> NWS!!! (nervous laughter) It certainly elicites a certain anount of fear in my psyche. Usually managed to get whacked by it when it was NCP LOL




Wayne, thanks for the link.  I don't have metastock, but apparently their data is compatible with Market Analyst, so will give their free trial a go.

NWS is a tame little duck compared to NCM     Not so sure about an iron condor with it's large fluctuations - perhaps a butterfly and make some adjustments as required - but then I don't like too much risk   .  Will watch with interest to see what you do with it - thanks for sharing.

Cheers,
Margaret.


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## happytrader (2 March 2006)

Hi Wayne and Sails

Out of simple curiousity just wondering what hour you predominantly make your move during the day?

Cheers
Happytrader


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## sails (2 March 2006)

Happytrader, it depends...   If timing doesn't matter (eg a neutral strategy such as a iron condor, butterfly, etc), I prefer to wait for the last half hour when there is the most liquidity.  Otherwise directional triggers could be anytime during the day.  

I often get often good directional entries/exits in the first half hour or so, but unfortunately some of our option MM's seem to have trouble getting out of bed    and don't start giving continuous quotes until they are ready.  The worst I have seen is CBA with no MM quotes until 45 mins after opening - sorry, just my vent   

Cheers
Margaret.


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## happytrader (2 March 2006)

sails said:
			
		

> Happytrader, it depends...   If timing doesn't matter (eg a neutral strategy such as a iron condor, butterfly, etc), I prefer to wait for the last half hour when there is the most liquidity.  Otherwise directional triggers could be anytime during the day.
> 
> I often get often good directional entries/exits in the first half hour or so, but unfortunately some of our option MM's seem to have trouble getting out of bed    and don't start giving continuous quotes until they are ready.  The worst I have seen is CBA with no MM quotes until 45 mins after opening - sorry, just my vent
> 
> ...




Thanks for that Margaret. I trade along very similar lines myself. Just thought it might be useful information for beginners contemplating trading derivatives. I remember being told 'time in the market is everything' and also that old favourite, 'the amateurs open the market and the professionals close it' I've found that to be pretty true most of the time for directional trades. Yes I agree with your comments about some of the MM habits. Never mind if you're right your right. They just annoy me when I'm  trying to sell quickly. 

Cheers
Happytrader


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## wayneL (2 March 2006)

HT,

Re trading times: I concur with what sails and you have discussed.

I have found even if the stock takes off with a fast move in the morning, a trade I would normally take with a stock, the delightfull MM's will screw you with price. So normally wait till at least the first hour is gone (amatuer hour).

Sails,



> some of our option MM's seem to have trouble getting out of bed




This is something, that at the moment, I have a great deal of empathy with. LOL 

The opening bell is 6:50 AM (cause I trade SPI as well) here in the west.  Most inconvenient :eek3:


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## wayneL (2 March 2006)

Bloveld said:
			
		

> Hello
> The IV that you have on the chart, how is it created?
> Is it the average IV of all calls, or puts and calls, or the IV of just 1 series?
> Is that metastock? If it is, how do you go getting the dates to line up in 2 different charts?
> ...




Steve,

It is an average across ATM/Close to money options and several expiries.

The data is, as far as Metacrash is concerned, a separate security. AMP verses AMP.iv for instance. You use the Insert/Security command and select the matching IV, drag it down to a new window and VOILA!

Be prepared for :aufreg: I crashed metacrap several times setting up the various charts.


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## wayneL (2 March 2006)

AMP has entered the lower quartile of it's 200 day IV range

Could be a Good op for some gamma trading or bought put? (I'm sceptical of the longside)


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## wayneL (2 March 2006)

Whats the deal with the strange AMP strikes?

<edit - never mind, I found the answer  >

http://www.asx.com.au/investor/pdf/notices/2006/Clm03106.pdf


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## wayneL (2 March 2006)

Just for fun, lets try some gamma trading (paper) on AMP

Buy AMPBY/AMPBX straddle @ the ask of 44c  ($8.48 march straddle)

Chose the front month to get maximum gamma.


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## wayneL (2 March 2006)

wayneL said:
			
		

> Just for fun, lets try some gamma trading (paper) on AMP
> 
> Buy AMPBY/AMPBX straddle @ the ask of 44c  ($8.48 march straddle)
> 
> Chose the front month to get maximum gamma.




It's all coming back to me what bastids these Aussie MM's are.

I was also looking at the april straddle as we are long vega as well as gamma...and with IV "purportedly" low.... 

The put quotes reeked of MM b@stardry, and sure enough they have them priced @ 26-28%.

This war!!!!!! LOL


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## sails (2 March 2006)

wayneL said:
			
		

> The put quotes reeked of MM b@stardry, and sure enough they have them priced @ 26-28%.
> 
> This war!!!!!! LOL



  don't often defend the MM's, but AMP goes ex-div on 27th March paying a div of 18c just 3 days before March expiry.


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## wayneL (2 March 2006)

sails said:
			
		

> don't often defend the MM's, but AMP goes ex-div on 27th March paying a div of 18c just 3 days before March expiry.




Ah yes, thanks Margaret. Haven't been playing dividend paying stocks in the US, so neglected to consider. Will have to remember to consider that. 

Thats why I'm dummy trading (it could be argued by some that that what I've always been doing  ), a new learning curve for me.

Thanks for picking that up.

Cheers

PS It's still war!!!


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## wayneL (2 March 2006)

sails said:
			
		

> don't often defend the MM's, but AMP goes ex-div on 27th March paying a div of 18c just 3 days before March expiry.




Yes that brings it back into line. ~20%IV  Thanks again.


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## sails (13 March 2006)

Hi Wayne,
Just wondering if you have done any IV/SV charts on BHP.  It's prone to overnight gaps much like NWS and IV's are currently running close to yearly highs which makes sense with the recent down moves.  Would be interesting to see some IV/SV history if it's not too much trouble.   
Thanks,
Margaret.


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## wayneL (13 March 2006)

Margaret,

Here is a 1yr chart.

I'm still fooling with my template, so a little explanation

IV is plotted in the lower pane in black with it's six month range in grey

22 day SV is plotted in both panes in red

10 day SV is in the upper pane, the green dashed line

100 day SV in pink

22 day SV has been oscillating in a fairly textbook channel whilst IV has been making higher highs, only in this latest peak has IV actually risen to the level of SV highs.

I will leave interpretation to you  (I am suffering from the aftereffects of a particularly good weekend    )

Cheers

<EDIT> chart has been corrected


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## sails (13 March 2006)

Thanks Wayne - will take some time to study these charts   .  SV really whips wildly around IV levels - probably explains why I've found it difficult to find the most suitable option strategies for BHP.  I'll do some backtesting on the basis of your charts and see what I come up with.  Will take a while as I have to do this manually and might give you time to recover from your weekend!


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## wayneL (13 March 2006)

sails said:
			
		

> SV really whips wildly around IV levels -




Yes, and this is what I am having to get used to. In the US the opposite is true. IV levels tend to whip around more than SV.


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