Trading Volatility

Paper Summary:

This paper explains that volatility is a measure of the uncertainty or risk of a given underlying, such as a stock, bond or index or the measure of the uncertainty of the return realized on an asset. The author points out that portfolios constructed to exploit volatility will always have opposing positions in stock and stock call options. The mix has to be balanced in such a way that the profit or loss on one component will always cancel the loss or profit on the other component. The paper relates that derivatives allow investors a choice on achieving their desired market exposure as opposed to undertaking transactions solely in the underlying stock resulting in lower volatility. The author presents several methods to adjust to volatility. Includes many graphs.

Table of Contents:
Introduction
Buying and Selling Volatility
Example of Trading Volatility
Causes of Volatility
Strategies
Simple Strategies
Strategies of Straddles
Strategies of Strangles
Rehedging a Portfolio
Volatility and Variance Swaps
VIX and VIX Options
Etc.

From the Paper:

"If the options are expensive enough, one may choose to take the opposite position and sell volatility. The short volatility strategy is exactly the opposite of the long volatility strategy in every respect and obviously can, in the right circumstances, produce profits. The basic strategy involves selling call options short and hedging with a long position in the stock. As with the long volatility play it is assumed that the individual has no view on the direction of the under lying and so the classic short volatility portfolio will have short call options perfectly hedged with a long stock position."

Sample of Sources Used:

• Emanuel Derman; Michael Kamal; Joseph Zou; Kresimir Demeterfi. A Guide to Volatility and Variance Swaps, The Journal of Derivatives, Summer 1999.
• Mayhew, S. and Mihov, V. (2000), 'Another look at option listing effects'. Working paper, University of Georgia
• Kevin B. Connolly 1997 "Buying and Selling Volatility", Wiley; Har/Dsk edition
• www.investopedia.com
• www.wikipedia.com

More papers on Trading Volatility:

• Research Paper # 24879 : "Day Trading"
• Term Paper # 148335 : "Volatility in the Global Economy"
• Research Paper # 64318 : "Volatility in the Stock Market and Short Term Trading"

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