Price Action

and finance Allah shmoop What is the volatility index or

Vicks No it's not this stuff not put that on

your equity trading sheet It just makes a mess and

little smells bad And no it's not a pre moistened

add either The volatility index Our vics is a measure

of quote market volatility unquote using sophisticated statistical measures But

in essence the vics is a reflection of expected options

Volatility like it kind of trades like a stock because

the elements that comprise it come from current market prices

of options on a variety of indices So what does

that mean in English again What the vics comes from

things like Calls on Nasdaq puts on the Russell 2000

way out of the money calls inputs on the S

and P 500 That air long dated you know stuff

like that Well the vics was created in 1993 by

the CBO your Chicago Board of Options Exchange to make

the management of hedging all the more liquid easy and

well lucrative the easier the indices are to use while

the more liquid the system and the more options contracts

then that get traded and the more commissions than that

Get aid So more money for everyone right Then again

not so much more money for professional options traders Less

money for cardiologists trying to be smarter than the $1,000,000

a week Goldman Sachs people The backdrop here is that

the fixes the key driver in the pricing of options

That is the more volatile the market the more valuable

options become both in hedging positions i e Playing investment

defense and in simply trading options When things are volatile

there exists more risk more money to be made more

money to be lost That happens So why do options

become more valuable when they're volatility is higher We'll take

a stock and 40 bucks a share with modest volatilities

such that in the last year it's traded as high

as 45 bucks a share in its low is 35

bucks a share A call option with a strike price

of college 47 50 would probably be pretty cheap if

it were bought when the stock was trading close to

35 it had an 045 months to expire And this

makes sense because the stock would have to go up

over 12 and 1/2 dollars for that option to be

at all in the money Remember that a stock prices

and kind of like a floating piece of cork in

the ocean It's absorbed a lot of water that is

in a calm sea The court can drop a couple

of feet in the water and a fish can pop

it up in the air a few feet and a

little kind of trade on its own But in rough

seas idea Volatile overall market Well that cork will not

only go up and down the two feet it travels

on its own but will be market multiplied by some

meaningful factor of the ocean tides going a 14 feet

up here and then 14 feet down Yeah so if

you take this very modestly volatile stock and then place

it in ah hi Vicks market volatile environment Well all

of a sudden the odds that that stock could trade

above 47 50 for some period of time before it

expires making the option worth more than a penny or

two Well then that risk suddenly gets very riel and

the pricing of those options immediately reflect that risk or

that positive upside of making money on the call options

you bought That is one can imagine that in a

market that upper down three or 4% per day idea

very volatile market Hello late 19 nineties The market gets

on a roll and the entire market goes up then

20% in a few quarters That's the entire market including

boring stocks like G and T and stuff like that

Well that long dated option you bought for a dime

when the stock was trading at 38 12 with the

strike price of 47 50 will just based on the

overall market going up 20% And in this particular stock

having a good quarter could make it trade for 50

bucks a share Putting that option $2.50 in the money

and giving you a 25 x return on the dime

per option investment that you made and about five months

earlier So yeah I think about the fixes the ocean

because it represents the overall volatility of the market itself

It then plays into the pricing of options or pieces

of cork floating in the waves And yeah that's the

vics Apply liberally to your problem areas