Thursday, September 23, 2010

Low Volatility, a Siren Song?

 
With the VIX residing close to its lowest levels in half a year, talk of buying volatility is coming back in vogue.  While the appeal of loading the boat with long volatility strategies is understandable, be aware that this particular temptation may turn out to be a siren song.
In Greek mythology, the Sirens were three dangerous bird-women, portrayed as seductresses who lured nearby sailors with their enchanting music and voices to shipwreck on the rocky coast of their island... The term 'siren song' refers to an appeal that is hard to resist but that, if heeded, will lead to a bad result.
In the world of volatility, traders would be well served to remember that everything is relative.  Though a VIX at 22 seems cheap compared to its recent range, keep in mind the following two things:  First, the historical mean of the VIX resides right around 20 which, at the least, should make traders rethink how cheap 22 really is.  Second, and perhaps more important, the only volatility that truly matters is how much the underlying stock actually realizes throughout the duration of the trade.  And, if current market volatility is any indication as to what the future holds, not only is 22 not cheap, it's arguably expensive.

Suppose we heeded the low volatility call and purchased Oct 113 straddles on the SPY.  At a current implied volatility of 20%, the straddle is pricing in roughly a 1.26% move per day.  For those disinclined to take the percentage route, that comes out to an expected daily move of about $1.42 (roughly 2/3 of the time).  In addition, this also means we should see the occasional move in excess of $1.42 (roughly 1/3 of the time). Unless you've had your head buried in the sand, you should know we have most definitely not experienced that type of movement in recent weeks (see 10 or 21 day historical vol). 

In sum, despite the ostensibly low volatility, straddle buyers still seem to face an uphill battle.  Unless you're of the opinion that either the market movement is poised to increase notably in the coming weeks or we're on the verge of a strong directional move, straddles are not a slam dunk buy here in my humble opinion.

For related content, readers can check out:
The Tempest and Volatility Analysis
Straddles and Gamma Scalping
Gamma Scalping Inquiry
Implied Vol vs. Historical Vol

9 comments:

Patrick said...

I believe those are harpies, sir, the Sirens try to get you to come onshore. But archetypically close enough. Harpies in this case would be the HFT bots that stop you out as you try to take a linear position.

Tyler Craig said...

Well, truth be told I originally had a pic of Sirens but let's just say the lack of clothing didn't resonate to well with my wife. Hence, the harpies...

Tyler Craig said...

The new pic should be more accurate. Thanks for the heads up:)

Penny stock newsletter said...

I have a web site where I give advise on penny stocks and stocks under five dollars. I have many years of experience with these type of stocks. If theirs anyone interested in these type of stocks you can check out my web site by just clicking Penny stock newsletter. I would like to comment about the future of the stock market theirs always bargains in the stock market you just have to be willing to take the time to find them. Speaking of stocks under one dollar that worked out for me. I recently sold my shares in vonage holdings corporation for 5 dollars. I bought the shares in 2009 for 37 cents. This was a rare exception to the general rule most of the stocks trading under 1 dollar are not good investments. The way that you find low priced stocks that are worthy investments is to have as much knowledge and experience as possible about these type of securities. Only than can you profit tremendously from these stocks.

internet meme blog said...

I'm a sucker for Greek Mythology..only I believe it all to be true. The sirens are very dangerous, and there are many modern day seductresses that we must be careful of! :)

website templates said...

Quite a knowledgeable to know on the highlighted matters and datas shared in this post in details.

timy loug said...

Your blogs are truly awesome I have no words to praise for your blogs. best penny stocks

Rose Maria said...

Thank you for your post. This is excellent information. It is amazing and wonderful to visit your site.
It really gives me an insight on this topic.
vix futures

mithila anderson said...

Trade in binaries and also realize the simplicity and simplicity. You can train about platforms using software provided at no cost. This software and the particular platforms provide real-time quotes, Binary Trading Software monitoring, reporting and investing. Just make a correct prediction and you also are in the funds.