Q&A
Explore Your Options
| Got a question about options? Tom Gentile
is the chief options strategist at Optionetics (www.optionetics.com), an
education and publishing firm dedicated to teaching investors how to minimize
their risk while maximizing profits using options. To submit a question,
post it on the STOCKS & COMMODITIES website Message-Boards.
Answers will be posted there, and selected questions will appear in future
issues of S&C. |
Tom Gentile of Optionetics |
OPTIONS ON SINGLE STOCK FUTURES
Do you know of a broker that allows trading in single-stock futures
and options?
Single-stock futures started trading in November 2002, but there are
no listed options on those contracts yet. Options might become available
in the future, but this has been a slow-go due to the cross-regulation
of single-stock futures.
VIX AND OEX IMPLIED VOLATILITY
Is it reasonable to assume that if the VIX goes from 12.23 to 45,
a factor of 3.68, that the implied volatility of the OEX 440 long put I
have will go from 34.02 to 125.15?
The CBOE volatility index (VIX or $VIX, depending on the quote service)
is a measure of the expected volatility priced into Standard & Poor's
500 ($SPX) options. The Chicago Board Options Exchange (CBOE) computes
the index using an options-pricing formula and then disseminates the latest
readings into the marketplace. The latest readings and charts can be created
with the symbol.
Prior to September 2003, the VIX was computed as the implied volatility
of the S&P 100 ($OEX) options. However, on September 22, 2003, the
CBOE changed the way the index is computed and, instead of tracking the
implied volatility of OEX options, the newer volatility index became based
on the more actively traded S&P 500 options contract.
The original formula VIX, which is based on the implied volatility of
OEX options, can still be accessed using the symbol VXO (or $VXO). At the
time of this writing, the VIX reads 13.1 and the VXO 12.4. If you create
a chart of the two volatility indexes, their movement is very similar.
This makes sense because the S&P 100 and the S&P 500 move in a
similar fashion and have the same levels of volatility from one day to
the next. Therefore, the option premiums on both the Spx and OEX will generally
have similar levels of implied or expected volatility.
So, to answer your question, it's very unlikely that the implied volatility
of the OEX would be 34 when the VIX is 12.23. Instead, if the VIX is near
12.23, OEX implied volatility and VXO would also be near 12.25 - maybe
a bit lower or higher. Further, if the VIX jumps by a factor of three or
four, it's safe to assume the implied volatility of the OEX will rise by
a similar amount. To see the longer-term trends graphically, consider creating
an overlay chart using the
symbols VIX and VXO.
TYPES OF SKEWS
I understand that skews occur when two options on the same underlying
asset have different levels of implied volatility, but I don't understand
the difference between price skews and time skews.
There are two types of skews: price skews and time skews. A price skew
occurs when options with different strike prices, but the same expiration
month, have different levels of implied volatility [IV]. This is common
in the index market where deep out-of-the-money (OTM) puts have higher
levels of IV when compared to at-the-money (ATM) or near-the-money options.
These skews developed after the stock market crash of 1987, as deep OTM
index puts became more widely used to protect portfolios.
The demand for these OTM puts caused the premiums or IV to rise above
the near-the-money or in-the-money (ITM) options. The crash caused some
permanent distortions-puts became more expensive than calls and price skews
developed across OEX strike prices.
A time skew occurs when the implied volatility of options that expire
during one month is different from the IV of options that expire during
a different month. The most common time skew occurs when the short-term
options have higher IV than the longer-term options. For example, ahead
of an earnings report, the implied volatility of the near-term options
will sometimes have higher levels of implied volatility than the longer-term
options. In essence, the options market is pricing in the earnings report
- that is, the short-term options are more expensive because there is a
greater chance that the stock will exhibit higher levels of volatility
in the near term because of the earnings report.
BUTTERFLY VS IRON BUTTERFLY
What is the difference between a butterfly spread and an iron butterfly?
A butterfly spread is a strategy that works well in a rangebound market
and is used to benefit from time decay. The standard butterfly is created
by selling two at-the-money (ATM) calls (or puts) and purchasing one in-the-money
(ITM) and one out-of-the-money (OTM) call (or put). The trade can be thought
of as a bear and bull spread combined.
The iron butterfly is similar, but uses both puts and calls. In this
trade, the strategist sells an ATM put and an ATM call, and then purchases
the OTM put and OTM call.
The idea in both the butterfly and the iron butterfly is for the underlying
asset to remain rangebound and for the short options to lose most of their
value due to time decay. Many of our students are finding a lot of opportunities
with butterfly spreads during this recent period of relatively low volatility.
Originally published in the April 2006 issue of Technical Analysis
of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 2006, Technical Analysis, Inc.
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