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“trade the volatility”

with 4 comments

Lots of this stuff boggles the mind, requires very very patient and concentrated searching around for slow explanations. Found a new favorite stumper today: one keeps finding folks advising the masses to “trade the volatility.” Trade the volatility… hmmm…. I know we live in strange days, when the demonic abstractions imagined into life by hedgefund mainframes are strutting across the brick and mortar surface of the world, spewing contagion as they pass. But it is hard, on first thought, to think exactly how one would devise an instrument that would allow you to “trade the volatility” in the markets itself. I can wrap my head around certain levels of abstraction – like trading risk, for instance, I can see how you can do that.

Volatility trading is still in its infancy, and not surprisingly critics abound. Naysayers suggest volatility is, in essence, a description of an asset’s return, not an asset unto itself. Yet most market players adopt the perspective that if it has a price, then it can be traded. (from here)

That seems like a good question from the naysayers in the crowd. And the response of the “market players” is pitch perfect. But there actually are instruments that you can buy (VIX futures contracts and VIX options…) to do this, but what are they, like, made of? Or are they simply pure betting table gambles, made of nothing more than the bet that you’d place at Ladbrokes on Wayne Rooney to score the first goal again Portsmouth this week? If you were doing it on “main street” (ugh) I guess you’d stock up on shotgun shells and can openers as well as oceanfront condos. But I can’t imagine that that’s how it works with these contracts.

Sometimes I wish I’d spent just a wee bit of time in the industry (where all of the lovely men I went to high school with are, er, or perhaps were) so I could understand this stuff. But that’s foolish isn’t it – they don’t know what these things are either. Silicon nightmares, terminator wisdom so far restricted to screens.

Does anyone know? Care to take a guess? OK, seriously, to work with me. Right now….

Written by adswithoutproducts

October 8, 2008 at 10:23 am

Posted in crisis, markets, wtf?

4 Responses

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  1. CR, “volatility” is actually at the absolute center of the development of the derivatives market. The Black-Scholes equation is designed to zero out risk around a given options transaction, leaving behind a single variable; this variable is know as the “beta,” or correlated relative volatility, of the option itself. And it’s that value, thusly, that sets the price of the option.

    Which makes it unclear what your “trade the volatility” people are on about; since 1973, all we do is trade the volatility. That’s the business of a hedge fund. What’s hot now is to “trade the correlation” — correlation being a further derivative fact of volatility. C’mon man, get with the (apocalyptic) times!


    October 8, 2008 at 2:08 pm

  2. ha! that’s pretty good. You should go on CNBC!

    So, packaged volatility would be like wrapped up quant-predicted valuation anomalies? Is that how it works? Or is it something else?

    the beta indicates the variation from market trends, no? the spread between the overall market’s performance and the underlying instrument’s performance?

    If that’s right, I still don’t think that’s trading volatility. I think that’s trading valuation anomalies. I’m looking for some sort of mindless carrier of pure volatility. I just got sort of excited thinking about that…

    Please go on, jane… Explain it.


    October 8, 2008 at 2:47 pm

  3. Hmm. I’m not sure your distinction is all that make-able. Beta is a number that bears an imperfect indexical relationship to a moment within a shifting structural condition. So, yes, it’s not “volatility itself.” But by the same token, price isn’t “value itself,” since it merely indexes a calculus about what the value might be in a given place and time, even though value is a constantly shifting structural condition.

    In that sense, you can’t trade (or buy) volatility itself, any more than you could trade value. But beta is one approach to volatility, just as correlation is another, being a derivative that approximates the chance of realized volatile activity producing further volatility. I’m telling you: if you want to trade volatility, correlation is where the action is!

    See note from July:


    October 8, 2008 at 8:29 pm

  4. we dont know


    May 13, 2009 at 12:34 pm

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