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Canox HK - Strategies for Index Options for the Rest of 2023
As we approach the end of this year in the stock markets, I'm reminded of a floor-trading adage: "Buy protection when you can, not when you're forced to."
When there seems to be no need to be concerned, security becomes an afterthought. The issue is that demand for "coverage" grows in a non-linear pace.
What does this mean?
In summary, you should purchase options when implied volatility is low and the market does not seem to be concerned.
If you don't have any alternatives for protection and an unfortunate incident forces your hand, the cost of that policy will almost certainly be far higher.
Price is a function of supply and demand. There are a limited number of enterprises that can provide optionality to the market. Currently, there is limited demand for longer-dated optionality (vega), but this might swiftly change.
In such case, the cost of six-month or one-year optionality might rise at a rapid pace. It conjures up images of a congested place with limited escapes.
Pop Culture "Lessons"
There has been a lot of speculation about the presence of UFOs and non-human life forms. In truth, a Pentagon official (David Grusch) testified before Congress regarding secret military projects that had existed for over 100 years.
The graph below shows the implied volatility for at-the-money (ATM) options on the Nasdaq-100® Index (NDX) (100% moneyness or 50 delta options). This data is five years old and includes the pandemic selloff (increase in volatility) as well as two previous all-time highs for US stock indices.
Nasdaq and NDX Live Vol Pro
With the exception of March 2020, the mid-term (six-month) and longer-term (one-year) NDX ATM IV ranged between 33% on the high end and 17% on the low end. To provide some perspective, the NDX's one-year realized (trailing) volatility ranged between 33% and 15% over the same time period.
Understanding that longer-dated option prices are more sensitive to changes in implied volatility estimates than identical (moneyness) shorter-dated options is key to solving this "puzzle." Let's put some figures around this idea.
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