LOOKING AT PAS T AND FUTURE
Why would option traders use these price
chart indicators when they can use vol-specific indicators to make trading decisions?
Generally, vol indicators reveal when options
prices may be cheap or expensive. When vol
is high, options prices might be expensive,
and when vol is low, they may be cheap. But
more to the point, what’s considered low or
high vol? Even when vol looks high, it could
go even higher. There’s no way to know with
certainty. Indicators such as Bollinger Bands,
ATR, and CVI look at past prices to indicate
prevailing price action. So, what if you combine these indicators with something that
looks more toward the future?
One choice is to use ImpVolatility (“
Implied”) on your thinkorswim® platform from
TD Ameritrade. The indicator is mean-reverting, and looks at the last 52-week high/
low range of a stock price to anticipate vol.
Keep in mind that some stocks may be more
volatile than others, which means vol will
vary from one stock to another.
PUT TING THEM ALL TOGETHER
Let’s combine all these indicators—ATR,
Bollinger Bands, CVI, and Implied—on one
chart and see how they work together.
In Figure 4, Bollinger Bands are overlaid
on the price chart, while ATR, CVI, and Implied are in the lower studies chart.
As you can see, when Bollinger Bands
narrow, these indicators would seem to agree
that vol is low. Notice how Implied takes the
lead and starts moving up. A few days later,
ATR and CVI move higher. And when all
three indicators start their upward move,
Bollinger Bands start expanding, and price
moves along the upper band. Then, Implied
traditionally starts to move lower, while the
other indicators might continue their move
upward. It’s not until price starts to revert toward the midline of the Bollinger Bands that
these indicators show a cooling down in vol.
You’ll often see this scenario play out in the
equity markets. After a consolidation period,
stock traders rush to buy the stock on the
first signs of an uptrend. After the initial rush,
price may mean-revert, and vol cools down.
A few months later, Implied moves
higher than the other indicators. Prices are
“walking along” the lower Bollinger Band.
All indicators show a high-vol environment. It’s fun to note that Implied tends to
spike when prices are lower on a relative
basis, possibly because stock traders tend
to buy when prices fall, thus increasing a
stock’s vol. The other indicators suggest
price may continue moving up. When such
scenarios occur, it’s worth heading over to
the Analyze tab on your thinkorswim platform to review the option chains and look
for premium-selling opportunities.
HIGH VOL IS IMPORTANT FOR AN OPTION
trader. The challenge is to find the stocks
with high vol, which is where these indicators come in handy. You could use price chart
indicators and vol-specific indicators as a
scanning tool to help identify high-vol trades
with relatively higher price ranges. You may
even get an idea of the potential direction
of price movement. The key is to have the
patience to wait for the right conditions.
Jayanthi Gopalakrishnan is not a representative of
TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the
author and may not be reflective of those held by
TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2.
FIGURE 4: Where is vol? Using ATR, Bollinger Bands, CVI, and ImpVolatility can help identify when vol is increasing or decreasing. Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
FIGURE 3: Chaikin volatility indicator. The indicator moves above and below the zero line smoothly. Source:
thinkorswim® from TD Ameritrade. For illustrative purposes only.
Peaks in CVI
indicate high vol