Market Technicians Association - September 2016 Implied ... · PDF fileImplied Volatility and VIX Outline Historical volatility tells us where we’ve been implied volatility is the

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

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endorsement, recommendation, or solicitation to buy or sell securities.

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Copies are available from your broker, by calling 1-888-OPTIONS, or from The Options Clearing

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of contemplated options transactions.

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This presentation should not be construed as an endorsement or an indication by CBOE of the

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Outline

Historical vs. Implied Volatility

Put / Call Parity

Single Day Implied Volatility

CBOE Volatility Index

Interpreting VIX

Resources / Contact



Volatility

Two Types of Volatility*

Historical Volatility – based on past

stock price changes

Implied Volatility – expected volatility based

on option market pricing



Option Price Components

Six Option Pricing Factors

Price of Stock

Option Strike Price

Time Until Expiration

Interest Rates

Dividends

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



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%


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



The Bell Curve

Standard Deviations Defined –

http://upload.wikimedia.org/wikipedia/commons/8/8c/Standard_deviation_diagram.svg

http://upload.wikimedia.org/wikipedia/commons/8/8c/Standard_deviation_diagram.svg



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



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


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


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


Put / Call Parity

Example – Payoff Table


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


Put / Call Parity

Example


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


Put / Call Parity

Example – Payoff Table


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)


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



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”



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



Inverse Relationship

Why?

“Because they are panicking”

- Billy Ray Valentine



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


SPX Put Volume > Call Volume

SPX Put Volume < Call Volume


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


Interpreting VIX


VIX vs. S&P 500®

Data Sources: CBOE & Bloomberg

10

20

30

40

50

60

70

80

1550

1650

1750

1850

1950

2050

2150


S&P 500

VIXNew SPX Low

VIX ‘Not

Confirming’ Low



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


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


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


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


Interpreting VIX


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



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


Summary

Resources / Contact

Resources

www.cboe.com/vix

www.cfe.cboe.com

Contact Info

Russell Rhoads, CFA

[email protected]

(Shameless plug –

I’m available for chapter presentations)

http://www.cboe.com/vix

http://www.cfe.cboe.com/

mailto:[email protected]

Market Technicians Association - September 2016 Implied ... · PDF fileImplied Volatility and VIX Outline Historical volatility tells us where we’ve been implied volatility is the

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