I'm looking to trade a long volatility strategy. Rather than getting roasted in real time, why don't you roast me now and save me some money. Here's my process below – how is this going to blow up?
Steps
– Backtest what happened to historic volatility when it was in a similar range as current levels
– If price historically moved either up or down by more than a straddle costs over time until expiry, buy a straddle
– Take profits at the typical move in the backtest
– …
– Profit?
That's basically it. Buy a straddle when the market is probably going to move more than the cost of the straddle. Scan hundreds of stocks to find the best cost in relation to typical move.
What could go wrong?
Roast my volatility trading strategy
byu/dddddd321123 inoptions
Posted by dddddd321123
5 Comments
[deleted]
Sounds like a decent starting point. It’ll take you hundreds of hours just getting a decent backtest, by then your three bullet points will have multiplied into 20 and the code for each one is going to be overwhelming. But yeah that’s how some people trade. Dm me if you ever run a backtest and want to bounce ideas
Another idea, find stocks with significantly lower IV than HV, measure average distance in time between IV percentile peaks, along with the average percent price changes between trough and peak. That way you’re buying cheaper strangles on otm strikes, you could incorporate analyst predictions and/or technical analysis to tilt your strangles heavier to call or puts hedging your position.
If you plan on market volatility going up, just buy an OTM put. The relationship between volatility and price for the stock market is pretty known; and as volatility goes up, price of the market will go down (for the stock market as a whole, but not necessarily with other assets, such as commodities, but I digress).
Buying the OTM put will be cheaper for you than buying an ATM one. There’s really no need to buy the ATM call if you’re expecting volatility to increase; that contract will still (more than likely) lose money if the market goes down and increases in volatility. Unless you’re that long call as some hedge against a breakout to the upside, of course.
I’m not sure why anyone would want to engage in any pure long volatility strategy. The downsides are significant:
>1. Volatility in option prices are derived from professional market makers who are extremely good at what they do and have an asymmetric information advantage;
>2. Volatility is typically overstated in option prices on average;
>3. Capital requirements are high and even if you’re right, you have to overcome a significant move before you make a decent return. You have to effectively surpass the mean absolute deviation of the volatility predicted by market makers before you make a dime.
The upsides are:
>1. I subscribe to Merton’s Jump-Diffusion model of market prices. So in my opinion there is some randomness in volatility and a propensity to have unpredictable significant moves followed by periods of low volatility.
>2. The market makers are always wrong. There will be periods of over and understated volatility each day.
So IMO a functional long volatility strategy would predict jumps, get long volatility before it occurs and close out after, before volatility compresses during diffusion. Unfortunately, despite a great deal of effort, I’ve been unable to predict the jumps in the jump diffusion process. I think they’re pretty much random.
Consequently, I think a pure long volatility strategy is a bad idea and if I were trading jumps, since I have no clue when they will occur, I would go long cheap wide strangles or short iron condors and expect to lose a lot of them while capitalizing on the 6 days a year where the market moves 100 points.