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Implied Volatility and VIX
Market Technicians Association - September 2016
Russell Rhoads, CFA
Director of Education – CBOE Options Institute
2CBOE OPTIONS INSTITUTE
Disclaimer
In order to simplify the computations, commissions have not been included in the examples
used in these materials. Commission costs will impact the outcome of all stock and options
transactions and must be considered prior to entering into any transactions. Multiple-leg
strategies involve multiple commission charges.
Any strategies discussed, including examples using actual securities and price data, are
strictly for illustrative and educational purposes only and are not to be construed as an
endorsement, recommendation, or solicitation to buy or sell securities.
Options involve risks and are not suitable for all investors. Prior to buying or selling an
option, an investor must receive a copy of Characteristics and Risks of Standardized Options.
Copies are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing
Corporation, One North Wacker Drive, Suite 500, Chicago, Illinois 60606. Investors
considering options should consult their tax advisor as to how taxes may affect the outcome
of contemplated options transactions.
CBOE and Chicago Board Options Exchange are registered trademarks and The Options
Institute is a servicemark of CBOE. All other trademarks and servicemarks are the property of
their respective owners.
This presentation should not be construed as an endorsement or an indication by CBOE of the
value of any non-CBOE product or service described in this presentation.
Copyright © 2016 Chicago Board Options Exchange, Incorporated. All rights reserved.
3CBOE OPTIONS INSTITUTE
Implied Volatility and VIX
Outline
Historical vs. Implied Volatility
Put / Call Parity
Single Day Implied Volatility
CBOE Volatility Index
Interpreting VIX
Resources / Contact
4CBOE OPTIONS INSTITUTE
Historical vs. Implied Volatility
Volatility
Two Types of Volatility*
Historical Volatility – based on past
stock price changes
Implied Volatility – expected volatility based
on option market pricing
5CBOE OPTIONS INSTITUTE
Historical vs. Implied Volatility
Option Price Components
Six Option Pricing Factors
Price of Stock
Option Strike Price
Time Until Expiration
Interest Rates
Dividends
Implied Volatility
6CBOE OPTIONS INSTITUTE
Historical vs. Implied Volatility
Pricing Calculator
Inputs
Price 51.00
Strike 50.00
Days to Exp. 30
Dividends 1.95%
Interest Rate 1.00%
Volatility 25%
Where does this number come from?
Output Call Put
Theo Price 1.90 1.10
7CBOE OPTIONS INSTITUTE
Historical vs. Implied Volatility
Pricing Calculator
Inputs
Price 51.00
Strike 50.00
Days to Exp. 30
Dividends 1.95%
Interest Rate 1.00%
Call Price 2.00
Implied volatility is determined by the
market price of an option.
Output
Volatility 30%
8CBOE OPTIONS INSTITUTE
Interpreting Implied Volatility
As a Forecast
Implied volatility may be taken as the market’s forecast of what
would be a one-standard deviation move over the life of an
option
Basic Example
XYZ at 100.00
IV of 1-year XYZ Options = 20%
1 Standard Deviation Move = +/-20 points
9CBOE OPTIONS INSTITUTE
Interpreting Implied Volatility
The Bell Curve
Standard Deviations Defined –
10CBOE OPTIONS INSTITUTE
Interpreting Implied Volatility
Converting Implied Volatility
Implied Volatility may be converted to a market price forecast
𝑺𝒕𝒐𝒄𝒌 𝑷𝒓𝒊𝒄𝒆 𝒙 𝑰𝒎𝒑𝒍𝒊𝒆𝒅 𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚 𝒙 𝑫𝒂𝒚𝒔 𝒕𝒐 𝑬𝒙𝒑𝒊𝒓𝒂𝒕𝒊𝒐𝒏
𝑫𝒂𝒚𝒔 𝑷𝒆𝒓 𝒀𝒆𝒂𝒓
Market expects underlying to be between up and down
12.40 at expiration with 68.2% certainty
𝟏𝟎𝟎. 𝟎𝟎 𝒙 𝟎. 𝟒𝟎 𝒙 𝟑𝟓
𝟑𝟔𝟓≈ 12.40
11CBOE OPTIONS INSTITUTE
Interpreting Implied Volatility
Converting Implied Volatility
On Day Implied Volatility Forecast
𝑺𝒕𝒐𝒄𝒌 𝑷𝒓𝒊𝒄𝒆 𝒙 𝑰𝒎𝒑𝒍𝒊𝒆𝒅 𝑽𝒐𝒍𝒂𝒕𝒊𝒍𝒊𝒕𝒚 𝒙 𝑫𝒂𝒚𝒔 𝒕𝒐 𝑬𝒙𝒑𝒊𝒓𝒂𝒕𝒊𝒐𝒏
𝑫𝒂𝒚𝒔 𝑷𝒆𝒓 𝒀𝒆𝒂𝒓
Market expects underlying to be between up and down
2.09 with 68.2% certainty
𝟏𝟎𝟎. 𝟎𝟎 𝒙 𝟎. 𝟒𝟎 𝒙 𝟏
𝟑𝟔𝟓≈ 2.09
12CBOE OPTIONS INSTITUTE
Put / Call Parity
Introduction
Three trading instruments – call, put, and stock
A long or short position in one of these instruments may be
replicated using two of the others
For example –
Long Call + Short Put = Long Stock
13CBOE OPTIONS INSTITUTE
Put / Call Parity
Example
Creating a synthetic long stock position using options
Buy 1 XYZ 50 Call at 2.00
Sell 1 XYZ 50 Put at 2.00
Net Cost = 0.00
14CBOE OPTIONS INSTITUTE
Put / Call Parity
Example – Payoff Table
Creating a synthetic long stock position using options
Profit / Loss is the same as
Long 100 Shares at 50.00
Stock Price Long 50 Call Short 50 Put P/L
40.00
45.00
50.00
55.00
60.00
(10.00)
(5.00)
0.00
5.00
10.00
(10.00)
(5.00)
0.00
0.00
0.00
0.00
0.00
0.00
5.00
10.00
15CBOE OPTIONS INSTITUTE
Put / Call Parity
Example
Creating a synthetic long stock position using options
XYZ at 51.00
Buy 1 XYZ 50 Call at 2.00
Sell 1 XYZ 50 Put at 2.00
Net Cost = 0.00
Option Trades are just like long 100 XYZ at 50.00
Sell Short 100 XYZ at 51.00
16CBOE OPTIONS INSTITUTE
Put / Call Parity
Example – Payoff Table
Creating a synthetic long stock position using options
P/L is +1.00 at any price level at expiration
Stock Price Stock P/L Long 50 Call Short 50 Put P/L
40.00
45.00
50.00
55.00
60.00
1.00
1.00
1.00
1.00
1.00
(10.00)
(5.00)
0.00
0.00
0.00
0.00
0.00
0.00
5.00
10.00
11.00
6.00
1.00
(4.00)
(9.00)
17CBOE OPTIONS INSTITUTE
Put / Call Parity
Relationships
Long Stock = Long Call + Short Put
Short Stock = Short Call + Long Put
Long Call = Long Stock + Long Put
Short Call = Short Stock + Short Put
Long Put = Short Stock + Long Call
Short Put = Long Stock + Short Call
18CBOE OPTIONS INSTITUTE
CBOE Volatility Index
Overview
The CBOE Volatility Index or VIX is a consistent 30 day measure
of implied volatility as indicated by S&P 500 Index option prices
The VIX Methodology is considered the industry standard for a
consistent measure of implied volatility
Historically VIX has displayed an inverse relationship with the
S&P 500 which resulted in it being referred to as “the fear
index”
19CBOE OPTIONS INSTITUTE
CBOE Volatility Index
2H2015 - 1H2016 Price Action
VIX vs. S&P 500®
Data Sources: CBOE & Bloomberg
10
20
30
40
50
60
70
80
1550
1650
1750
1850
1950
2050
2150
Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16
S&P 500
VIX
20CBOE OPTIONS INSTITUTE
CBOE Volatility Index
Inverse Relationship
Why?
“Because they are panicking”
- Billy Ray Valentine
21CBOE OPTIONS INSTITUTE
CBOE Volatility Index
Inverse Relationship
S&P 500 Put Call Ratio
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16
SPX Put Volume > Call Volume
SPX Put Volume < Call Volume
22CBOE OPTIONS INSTITUTE
Interpreting VIX
VIX as a Market Indicator
VIX may be thought of as a sentiment indicator that shows
excessive market complacency or fear
Some market participants like to use VIX as a confirmation or
new S&P 500 lows
If VIX is not making a new high as the S&P 500 makes a new low
the result may be a short term stock market bottom
23CBOE OPTIONS INSTITUTE
Interpreting VIX
VIX as a Market Indicator
VIX vs. S&P 500®
Data Sources: CBOE & Bloomberg
10
20
30
40
50
60
70
80
1550
1650
1750
1850
1950
2050
2150
Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16
S&P 500
VIXNew SPX Low
VIX ‘Not
Confirming’ Low
VIX as a Market Indicator
24CBOE OPTIONS INSTITUTE
Interpreting VIX
VIX Futures Pricing
Unlike many financial futures markets there is not a ‘fair value’
relationship between VIX and the associated futures contracts
At times VIX futures are priced at a premium to spot VIX and at
times VIX futures will be priced at a discount
The pricing relationship is often referred to as being in
contango or backwardation
25CBOE OPTIONS INSTITUTE
Interpreting VIX
Volatility as a Tradable Asset
VIX and Related Futures Pricing (Brexit)
16
18
20
22
24
26
VIX Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17
Thursday Close
Friday 6:30 am
Chicago Time
26CBOE OPTIONS INSTITUTE
Interpreting VIX
Standard Futures Daily Price Chart
VIX vs. December 2015 Futures
12
16
20
24
28
9/16 10/7 10/28 11/18 12/10
December VIX
Spot VIX
December
Front Month
27CBOE OPTIONS INSTITUTE
Interpreting VIX
Modified Futures Contract
Standard VIX futures contracts expire each month
As expiration approaches the spread between spot VIX and the
futures contract narrows
To compensate for this aspect of VIX futures price behavior a
method was developed to compare with spot VIX
The front two month futures are time weighted and the result is
a modified VIX Futures Contract
28CBOE OPTIONS INSTITUTE
Interpreting VIX
VIX as a Market Indicator
Modified VIX Future
1400
1600
1800
2000
2200
10
15
20
25
30
35
40
45
50
Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16
VIX
Mod VIX Futures
S&P 500
29CBOE OPTIONS INSTITUTE
Implied Volatility and VIX
Outline
Historical volatility tells us where we’ve been implied volatility
is the market’s forecast of where we are going
Put / Call Parity keeps option market pricing in line with the
underlying and option options on the same stock
Implied volatility is an annualized number which may be used to
project the market’s expectation of price changes over any time
period
The CBOE Volatility Index (VIX) is a consistent measure of
implied volatility focusing on a 30 day time period
VIX and the relationship between the index and futures pricing
is a potentially useful market indicator
30CBOE OPTIONS INSTITUTE
Summary
Resources / Contact
Resources
www.cboe.com/vix
www.cfe.cboe.com
Contact Info
Russell Rhoads, CFA
rhoads@cboe.com
(Shameless plug –
I’m available for chapter presentations)
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