dutchie said:
G'day Wayne,Sails & Magdoran
I was wondering what the best way would be to start plotting implied volatility for a share (ASX).
1. Use the ATM Call value at the e.o.d. for the current month?
2. Get the volatility value from the ASX site ? or
3. Get the last price of the ATM Call option on the day and put it into the Black-Schooles formula from Hoadley site and work out the IV?
4. I know different strike prices would have different IV's but as a average value (especially to compare the changes of IV day to day) the ATM value is the best bet?
5. Would it be better to plot the average of the last "x" days?
6. When it was close to expiry date would it be better to jump to the next month?
Cheers
Dutchie
Hello dutchie,
Implied Volatility (IV) is a tricky beast. How you determine how to use it depends a lot on what you’re trying to achieve, and what your preferences are since there are many different ways to look at it. Wayne, Margaret, NetAssetts, and other contributors will all have their own approach to how they interpret and use IV.
Model:
Determining which model you use can also make a difference in some cases, a lot again depends on what you’re looking at. I use Binomial/American exercise for the ASX, but have to set the number of steps to around 25-30 or else my PC chugs (Have 2 gig ram, and 32 HT etc and it still chews up the cpu if set to 50 steps).
Black and Scholes has some distortions in the model, which become evident with some calendar spread value returns which are incorrect, so just be aware of this. Also, Black and Scholes was designed for European exercise hence it returns values that doesn’t take into account the theoretical added value for American exercise.
IV:
IV average is exactly that, the average for all the strikes at different levels and expiries, so it can be a little misleading to use it as your benchmark in many instances. Also note that dividends can move the IV for calls down, and IV for puts up nearing ex div.
I change the focus of my IV estimation depending on what I’m doing – which strategy I am looking at, what the time frame is, and what expiry time there is in the options I’m looking at, what the constituent parts are (calls/puts, ATM/OTM/ITM, & expiry).
For example, if you’re looking at long term options, and only calls, you may want to compare the 90+ IV averages, average IV for all calls, the overall IV average, and then compare the same strike in different months, and all the strikes in the same month.
I factor in where the current IV is in relation to the range in the appropriate time frame. Say you expect to be in the trade for a month, you’d probably look at the current month, and maybe 3 months out. If you expect to be in the trade for 0-7 days, you may only want to look at the current month. Say you expect to be in a trade for 3 months, you’d probably look at the past 6 months.
But this varies a lot depending on your judgement. A lot depends on your view of the underlying, and the way that volatility is trending itself. I actually think you can read volatility charts just like you can standard OHLC underlying charts, although how you look at them is a little different. In a way you need to correlate the underlying movement with the respective IV movement.
I tend to ignore last prices, and focus on the model price, but this is a personal preference. I look at the way the underlying is trending, and try to estimate where IV may move depending on future movements in the underlying.
Generally, strong down moves in the underlying tend to increase IV (sometimes significantly). Strong up moves can too, but not always. Small inside days and prolonged sideways movement in the underlying or gentle trends tend to see IV move down. The expectation of news and rumours can make IV spike up, and when the item is known, cause it to spike back down again, depending on what the underlying does.
IV can differ for calls and puts for a variety of reasons. Also, activity in the front months (less than 45 days time value) can really swing IV values around (more so in the US than Australia). So, if you’re trading 60+ days, you may find the front month IV irrelevant to your strategy. The core point is to find information that is relevant to what you are doing.
If you’re doing 2 or more legs, you’re looking for favourable skews where you want to sell higher IV and buy lower IV. You want the later IV movement for your positions to move as favourably as possible. If for example you’re looking at low volatility entry spreads such as reverse ratio spread calendarised puts and calls as one unit (sell OTM lower number/ratio calls and puts in the front month, buy higher number/ratio of calls and puts in a later month closer to the money), volatility becomes critical.
But any of the approaches you suggested, or the ones I’m mentioning here, or the ones others may venture later, are all worth considering, and the more you trade, the more you’ll find approaches that work for you depending on your broader approach.
Regards
Magdoran