Equity Volatility: Managing and Profiting

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Equity Volatility: Managing and Profiting. Greg Levinson Chief Investment Officer Schooner Investment Group FPA Meeting July 21, 2010. Volatility Basics. Just Kidding!!. _______________________________________________________________________. - PowerPoint PPT Presentation

Text of Equity Volatility: Managing and Profiting

  • Equity Volatility:Managing and ProfitingGreg LevinsonChief Investment Officer Schooner Investment Group FPA Meeting July 21, 2010

  • *Volatility Basics

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    Just Kidding!!

  • *Goal for this Presentation If you can't explain it simply, you don't understand it well enough. - Albert Einstein _______________________________________________________________________

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  • *Greg Levinson Wharton School, University of Pennsylvania, 1995.Former Managing Director BNP/Paribas Cooper Neff.Founder and Former Managing Member, Polaris Advisors LP.Founder and Managing Member, Schooner Investment Group._______________________________________________________________________

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  • *About SchoonerRadnor, Pa Based RIA.Boutique Specialty Manager focusing on equity volatility strategies.Core Investment team has worked together over 15 years.Formed in January 2008 to offer teams investment expertise in liquid and transparent vehicles. Institutional Investment Manager Only.Advisor to 40Act Mutual Fund.Sub-advisor for other Advisors.

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  • *Defining Volatility

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  • *Defining Volatility Variation from the average value over a measurement period. (standard deviation) Volatility does not equal Risk.Volatility is just one quantitative metric of risk.Risk is a concept.Volatility can create opportunity. MPT and Efficient Frontier: rely upon standard deviation as the singular metric of risk.

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  • *Approximations of VolatilityIt can be approximated by saying that if the volatility is calculated by the standard deviation of the asset prices. Then approximately 2/3 of the time the price will be within one standard deviation of the average price over time. Measurement period is important.Mean and SD quoted as an annualized number: Daily Vol = / _______________________________________________________________________

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    t

  • *Normal Curve Distribution_______________________________________________________________________

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  • *Historical Realized Volatility Calculated by measuring the assets past price movements.

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  • *Future Forecast Volatility _______________________________________________________________________

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  • *Future Forecast Volatility Forward volatility can never be known, because the time frame is the future.Estimate is based upon more than the volatility history of the asset.Takes into consideration any events that are known to be occurring during forecast period.

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  • *Implied VolatilityUnlike other types of volatility, this is a property of the option (rather than of the asset). Estimate, made by professional traders in the marketplace, of the future volatility of the asset. The volatility, that when substituted into the equation used to calculate theoretical values, makes the theoretical value equal to the actual price of the option in the marketplace. _______________________________________________________________________

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  • *Volatility Price ExampleSPY current price = 100

    If the price of 30 day, 100 strike puts or calls = $1Then implied volatility is 10Security Bullish / Vol Buyer : Buy CallsSecurity Bearish / Vol Buyer :Buy Puts

    If the price of 30 day, 100 strike puts or calls = $4Then implied volatility is 35Security Bullish / Vol Seller : Sell PutsSecurity Bearish / Vol Seller : Sell Calls

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    What is the VIX?

  • *What Does VIX - CBOE Volatility Index Mean?Index which shows the options markets expectation of 30-day volatility.Constructed using the implied volatilities of a wide range of S&P 500 index options.Intended to be forward looking and is calculated using both calls and puts.VIX considered to be premier barometer of investor sentiment and market volatility.VIX is a calculated index, not a security.

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  • *VIX closing levels since introduction

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  • *VIX = FEAR INDEX_______________________________________________________________________

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  • *VIX = FEAR INDEX_______________________________________________________________________

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  • *Put/Call ParityPUT = CALL STOCK + PV(STRIKE)A Put can be replicated by buying a call and selling the stock short; A call can be replicated by buying a put and buying stock.When current stock price and strike are the same, then the price of the put equals the price of the call.Any violation allows for riskless arbitrage opportunities.The price of puts affects the price of calls, and vice versa.Example is for illustrative purpose and assume options in simplest form: European exercise, no dividends, flat borrow/lending rates, no shorting restrictions/costs

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  • *Put/ Call Parity Example Stock at 100 100 strike call = $2 ; 100 strike put = $3$1 Arbitrage exists buying call, selling put and shorting stock.

    If at maturity stock is $80, then make $20 selling stock short, lose $17 from selling put, and lose $2 from worthless call expiration for total $1 profit.

    If at maturity stock is $120, then lose $20 selling stock short, Make $18 from purchasing call, and make $3 from worthless put expiration for total $1 profit.

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