In viewing Merrill Lynch's Volatility Chart on April 5, 2002 we noted that the statistical volatility (SV) and implied volatility (IV) percentile rankings ("SV[1] IV[4]" displayed below the chart title) were at historically low levels in comparison to the previous 4 years.

IV (blue line) had recently turned higher suggesting the volatility trend may have changed and was beginning to rise. The 3-week to 6-year average volatility levels (shown in the lower left quadrant of the Volatility Chart window) were taken into consideration when we estimated how high implied volatility may rise from it's then-current levels. We could also see that, historically, it had taken approximately 6 months (time divisions are Apr/Oct) to cycle from historically low levels to extreme high levels.

When viewing the Matrix, we wanted to consider options that had a minimum of 6-months of time to expiration. [The "days to expiration" (life of the option) is displayed next to each expiration month <days>].

Without taking a directional opinion, a Delta neutral strangle was constructed by buying calls and puts that were slightly out-of-the-money. With MER then in the $55 range, the $60 calls and $50 puts were chosen.

After viewing the MIV (IV for the Midpoint between the bid and ask) for the $50 call and $60 put for each month, the JAN03's were chosen as the average MIV for the calls and puts was the lowest and they had 9+ months to expiration (which also satisfied our needs).

Through a little trial and error, we selected a ratio position of 9 $60 calls and 10 $50 puts that was relatively Delta neutral (6.10 Deltas). This position also had a long vega position of 340 that suggested the position would increase in value by $340 for every 1% rise in IV, which also satisified our criteria.

In addition, the position was long gamma and therefore would work in our favor from any exaggerated move in either direction. This strangle required $8,854 of capital to establish the position, including $83.70 in commissions.

We generated a Graphic Analysis to view a pictorial representation of how this trade would theoretically react from that point in time until expiration. For analytical purposes, we increased the "volatility change" by 13% (highlighted in blue) to see how the position would react if implied volatility levels increased to those similar to those present in the 1.5-6 year averages.

By selecting the "T+144 dashed line" (highlighted in bright blue) we viewed the projected value of this strangle across different price points 144 days (approximately 5 months) in the future. In the extreme lower left, the probability of profit, or "P.P.", suggested that this trade would have a 77% chance of a profitable outcome should volatility increase by 13% over the next 144 days regardless of what happened with the underlying stock price.

On September 5, 2002, this strangle would have generated just over $6,700 in profit! That's nearly a 76% yield on our $8,854 investment - the annualized yield was over twice as much!

Making OptionVue 5 work for you!

In this example, OptionVue 5 helped recognize a situation where implied volatility was extremely low compared to it's historic range, projected the outcome with a 13% increase in implied volatility (based on historical information), and displayed the projected results graphically for us to view and understand. Ultimately, the stock made an exaggerated move and the trade provided better than expected results due to our position choice and the assistance of OptionVue 5!

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