Options trading driven by volatility directional accuracy

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Abstract:

Analysts have claimed over the last years that the volatility of an asset is caused solely by the random arrival of new information about the future returns from the underlying asset. It is a common belief that volatility is of great importance in finance and it is one of the critical factors determining option prices and consequently driving option-trading strategies. This article discusses an empirical option trading methodology based on efficient volatility direction forecasts. Although in most cases accurate volatility forecasts are hard to obtain, forecasting the direction is significantly easier. Increase in the directional accuracy leads to profitable investment strategies. The net gain is depended on the size of the changes as well; however successful volatility forecasts in terms of directional accuracy was found to be sufficient for positive results. In order to evaluate the proposed methodology weekly data from CAX40, DAX and the Greek FTSE/ASE 20 stock indices were used.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840500427999

Affiliations: 1: Forecasting Systems Unit, School of Electrical and Computer Engineering, National Technical University of Athens, 9 Iroon Polytechniou Street, 15773, Zografou, Athens, Greece 2: Supply Chain Management Research Group, Decision Sciences and Operations Management, Manchester Business School, University of Manchester, UK, M15 6PB Manchester 3: Forecasting Systems Unit, School of Electrical and Computer Engineering, National Technical University of Athens, 9 Iroon Polytechniou Street, 15773, Zografou, Athens, Greece,Ministry of Economy and Finance, 10180 Athens, Greece

Publication date: February 1, 2007

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