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Strategies & Market Trends : The Covered Calls for Dummies Thread -- Ignore unavailable to you. Want to Upgrade?

To: Uncle Frank who wrote (773)	5/24/2001 4:05:22 AM
From: JohnM	Read Replies (1) \| Respond to of 5205

On the beta question, Frank, I actually understood you to be saying it to mean exactly what the quotes were. So there was no misunderstanding. Unless your silent critic wishes to offer another explanation. My question, unasked, about that quote was different. What, and this should go to anyone that might understand, is the relation between stock betas and option premium prices? Is it the case that high beta stocks get high option premiums? (I seem to have read that somewhere.) If that is the case, I can imagine why that is so--more unpredictability for the option buyer/seller, should increase the reward. But is that the case? And, then, of course, there is the option premium pricing issue. I vaguely understand that's extraordinarily complicated, have been led to believe that Merton, Scholes, and or Black, but perhaps it was just Merton are responsible for the math that is used and that one, two, or three of them received Nobel prizes for that work. It's, of course, off topic to discuss whether that was wise, whether offering the Nobel for economics is wise, whether offering it to so many Chicago economists is wise, etc. (g) Whoops, just have to stop before I get too worked up. Oh, before I stop, I wish to thank everyone who has responded. Thinking this through genuinely helps. As I've said before, the logic for writing calls takes some getting used to. I've discovered if I talk each scenario through carefully with my wife, I begin to see what I don't know. Doing the same here, with folk who know their way around the ballpark is exceptional. Not only saved me money but gave me the confidence to actually do it. John

To: Uncle Frank who wrote (773)	5/28/2001 3:43:36 PM
From: BDR	Read Replies (1) \| Respond to of 5205

<<Perhaps one of the wunderkind (Ethan or Mathmage) will be kind enough to offer a mathametical explanation of the difference between the two terms in practical applications.>> First a disclaimer: I have known some wunderkinds and I am no wunderkind. For option writers volatility is important in that it is one factor that determines the premiums. Beta does not and I don't think there is necessarily any correlation between the two. A high beta stock could have a low volatility and vice versa. Volatility is a measurement of movement based on shorter time intervals. Beta is a measurement not only of movement but also direction (a vector?) over longer time intervals. Mathematically perhaps beta is something like the integral of volatility. But now I am out of my depth. I have probably said enough wrong that it will stimulate the mathematicians lurking here to step forward and tell how these terms really relate. Your question caused me to read further on the subject (always dangerous since it can lead to facts getting in the way of my opinions) and I came across the following from the CBOE site: cboe.com Volatility With regard to stock prices and stock index levels, volatility is a measure of changes in price expressed in percentage terms without regard to direction. This means that a rise from 200 to 202 in one index is equal in volatility terms to a rise from 100 to 101 in another index, because both changes are 1 percent. Also, a 1 percent price rise is equal in volatility terms to a 1 percent price decline. While volatility simply means movement, there are four ways to describe this movement: 1. Historic volatility is a measure of actual price changes during a specific time period in the past. Mathematically, historic volatility is the annualized standard deviation of daily returns during a specific period. CBOE provides 30 day historical volatility data for obtainable stocks in the Trader's Tools section of this Web site. 2. Future volatility means the annualized standard deviation of daily returns during some future period, typically between now and an option expiration. And it is future volatility that option pricing formulas need as an input in order to calculate the theoretical value of an option. Unfortunately, future volatility is only known when it has become historic volatility. Consequently, the volatility numbers used in option pricing formulas are only estimates of future volatility. This might be a shock to those who place their faith in theoretical values, because it raises a question about those values. Theoretical values are only estimates, and as with any estimate, they must be interpreted carefully. 3. Expected volatility is a trader's forecast of volatility used in an option pricing formula to estimate the theoretical value of an option. Many option traders study market conditions and historical price action to forecast volatility. Since forecasts vary, there is no specific number that everyone can agree on for expected volatility. 4. Implied volatility is the volatility percentage that explains the current market price of an option; it is the common denominator of option prices. Just as p/e ratios allow comparisons of stock prices over a range of variables such as total earnings and number of shares outstanding, implied volatility enables comparison of options on different underlying instruments and comparison of the same option at different times. Theoretical value of an option is a statistical concept, and traders should focus on relative value, not absolute value. The terms "overvalued" and "undervalued" describe a relationship between implied volatility and expected volatility. Two traders could differ in their opinion of the relative value of the same option if they have different market forecasts and trading styles. CBOE Volatility Index - VIX™ One measure of the level of implied volatility in index options is CBOE's Volatility Index, known by its ticker symbol VIX. VIX, introduced by CBOE in 1993, measures the volatility of the U.S. equity market. It provides investors with up-to-the-minute market estimates of expected volatility by using real-time OEX index option bid/ask quotes. This index is calculated by taking a weighted average of the implied volatilities of eight OEX calls and puts. The chosen options have an average time to maturity of 30 days. Consequently, the VIX is intended to indicate the implied volatility of 30-day index options. It is used by some traders as a general indication of index option implied volatility. Implied volatility levels in index options change frequently and substantially. Consequently, when trading short-term index options, traders should forecast the index level, the time period, and the volatility level. Traders of long-term index options should also include a forecast of interest rates. (The volatility discussions above are excerpts from the book Trading Index Options by James B. Bittman. This book is available through our online bookstore.)