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Preparing for a Volatility Increase
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By Lawrence McMillan, President, McMillan Analysis Corporation,
Author and Lecturer
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Before
you declare me insane for even mentioning the words “volatility”
and “increase” in the same sentence, let me
point out that I am not saying that volatility will increase
immediately. However, it will certainly increase sometime,
and that could happen as soon as the second half of 2005.
Remember: July 1st is the traditional low point for $VIX
for the year. So, after that, $VIX generally increases
-- albeit in fits and starts -- until October.
When volatility increases, straddle buying is often the preferred strategy. However, it has been a poor strategy for the past year-and-a-half or so, due to a persistent decrease in implied volatility across nearly all stocks and indices. Will straddle buying ever resume a prominent place in the volatility trader’s arsenal, and, if so, how will one know when it’s time to resume using the strategy in earnest?
This
is a difficult problem with, likely, no clear solution.
Essentially, the difficulty arises from trying to determine
when it’s time for straddles to be bought. After
such a long period of dormant volatility, the standard
measures -- such as options being “cheap”
or historical volatility being “low” -- are
not going to work. Probability analyses and expected returns
are likely to yield unfavorable predictions even though
trades may work out nicely in actual practice.
Click here to read entire article.
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“Before you declare me insane for even mentioning the words “volatility” and “increase” in the same sentence, let me point out that I am not saying that volatility will increase immediately. However, it will certainly increase sometime, and that could happen…"
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