Question

Strategies through which one can profit as a function of one’s directional and volatility views. How can you go about forming directional and volatility views? In what ways might your directional view interact with your volatility view?

Answer 1

Answer

Strategies through which one can profit as a function of one’s directional and volatility views.

Iron condors/strangles/straddles (or any other option strategies) are affected by volatility, but are NOT pure volatility plays.

All option strategies are affected by a myriad of factors besides volatility, including but not limited to: directional movement in the underlying (delta), rate in change of delta (gamma), time passing (theta), interest rates changes (rho), etc..

If you want to take a pure directional bet on volatility, you can use volatility-related futures, such as the VIX futures.

How can you go about forming directional and volatility views

One can form a directional view by closely examining an asset, being a stock, bond, index, etc. and forming a decision about the direction that the asset will take in the future (the price will increase or decrease), while considering the market as a whole and the particular industry that influences the asset. Once you have drawn a conclusion based on his research and analysis of the asset, he could then decide whether he is directionally bullish, bearish, or neutral.

In what ways might your directional view interact with your volatility view?

Volatility of a stock may incur a risk premium, leading to a positive correlation between volatility and returns. On the other hand the leverage effect, whereby negative returns increase volatility, acts in the opposite direction.

Futures on VIX provide a pure play on implied volatility independent of the direction and level of stock prices. VIX futures may also provide an effective way to hedge equity returns and to diversify portfolios.