Trading Volatility Not Price

If would appear from the results of the previous post that volatility should be more predictable than price. If there is a way to buy and sell the volatility of a security as opposed to the security itself, it should be much easier to make profitable short term trades.

What one needs to understand now is how to translate the apparent predictability of volatility into actual trading strategies.

The following chart shows the VIX, the implied volatility index of the US stock market calculated from the components of the SP500 index, over a period of a few years. The VIX is plotted in red with the SP500 in black in the background for a comparison.



Just below I have added the value of the VIX as a percentage of the VIX range over the past 252 days (a trading year) and over the past 63 days (a trading quarter). One can see that the VIX spends most of the time in the 20-80% region of the range. It spends less time in the lowest 20 percentiles of the range, depending on the time frame considered to calculate the range, and even less time in the highest 20 percentiles of the range.

If one takes a look at the following chart of the VIX,



will see at the bottom the standard deviation of the VIX calculated over a period of 252 days and over 63 days. The chart of the VIX shows superimposed the Bollinger bands for the corresponding time periods. Here one can see that when the VIX is in the low percentiles of her range it almost never breaks below the lower Bollinger band, regardless of the time frame. On the other hand, when the VIX is in the high percentiles of her range, the upper Bollinger band is unable to contain it and the VIX spikes above it briefly.

Categories: stock options, volatility, delta neutral
Technorati Tags: stock options, volatility, delta neutral