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Our
Philosophy
Derivative
products, by their nature, imply a projection of the
forthcoming volatility of the underlying stock or futures
contract. If the actual volatility of that market differs
substantially from the calculated volatility that is being
projected by the option market, then a trading opportunity
exists. It is our primary aim to spot such situations, based
on mathematical comparisons of volatility levels, and then
construct a strategy to profit from that mis-pricing of
volatility.
In
general, these strategies are structured so that actual price
movements by the underlying futures contract are not the only
determinant of profitability, but rather the strategy would
attempt to benefit from a correct prediction of volatility.
In
reality, price and volatility are related, so it is difficult
to separate them for more than a brief period of time.
However, the strategies utilized are constructed so that as
much of the price movement as possible is neutralized. For
example, if volatilities are too low, a straddle would be
purchased. A straddle is the purchase of both a put and a
call. While some strategies will occasionally be directed
towards situation in which implied volatility is too high,
then primary focus will on finding situations where the
volatility is too low. For the former involves naked options
and they entail large risks. as such, those strategies are
used sparingly, if at all. |
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The
4-Step Analysis Process
In
order to spot viable volatility buying opportunities, it
is necessary to utilize a rigorous, statistical
approach. Very little "market opinion" goes
into the selection of these trades:
1.
Identify Cheap Options
Using a composite implied volatility of the options
that trade on each entity every day, we can identify
situations where the options are trading at levels far
below where they have normally been shown to trade in
the past. These are cheap options.
2.
Calculate the Probabilities
A proprietary Monte Carlo probability analysis is then
done to determine if the underlying market has the
ability to move the required distance in order to make
the hedged strategy profitable.
3.
Observe Past Price Movements
The final statistical step in the analysis is to
discern if the stock has displayed enough volatility in
its past movements in order to be able to move the
required distance in the allotted amount of time.
4.
Check the Fundamentals
While fundamental analysis plays little or no part in
our selections, a check of the fundamentals is required
in order to determine if there is a valid reason why the
options are so cheap (such as a all-cash takeover bid). |
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