{"id":154238,"date":"2012-07-24T14:00:00","date_gmt":"2012-07-24T08:30:00","guid":{"rendered":"http:\/\/stockviz.biz\/index.php\/?p=154238"},"modified":"2012-07-19T17:49:50","modified_gmt":"2012-07-19T12:19:50","slug":"understanding-volatility-part-iii","status":"publish","type":"post","link":"https:\/\/stockviz.biz\/index.php\/2012\/07\/24\/understanding-volatility-part-iii\/","title":{"rendered":"Understanding Volatility – Part III"},"content":{"rendered":"

\"image\"<\/a>We discussed historical and implied volatility previously<\/a>. The question now is how to profit from it. As you can see from the chart on the left, the market implied volatility (VIX) keeps oscillating (greed-fear-greed-fear\u2026) A simple strategy could be to sell when VIX is at its lows (greed is predominant) and buy when VIX peaks (fear is predominant). Notice the (loose) correlation between Nifty<\/a> peaks\/troughs with the VIX troughs\/peaks. <\/p>\n

Buy why trade the underlying (in this case, the Nifty), when you can trade volatility directly? Using stock & index option strategies, you can profit from volatility while being indifferent to the actual underlying scrip. For example, you can buy Straddles (Nifty August 5200 Long Straddle<\/a>) that appreciate in value if volatility increases, irrespective of whether the underlying stock increases or decreases in value. Ditto with Strangles (Nifty August 5200\/5300 Strangles<\/a>). <\/p>\n

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Caveat: it depends on how much you pay to put on the trade. If increasing volatility is \u201cpriced-in\u201d, then the trade may not be profitable even if the target volatility level is reached, as the following pay-off diagram illustrates.<\/em><\/p>\n

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Nifty Strangle & Straddle<\/div>\n<\/div>\n

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Volatility strategies are often used when the fundamentals of the underlying scrip is in doubt. For example, there was a fair amount of uncertainty around INFY<\/a> results: global IT spending slowdown plus company specific problems. However, it has a track record of execution and is considered to have good corporate governance (ie, a good company to own long term.) So instead of taking a directional bet on the stock, traders put on straddles betting on volatility<\/a> instead. <\/p>\n

To conclude our discussion:<\/p>\n