I am still trying to get my hands around implied volatility - you keep adding faces to the "Rubik's cube". You brought up NVDA as an example for a play on i.v. I was hoping I could walk through a few questions on this example. I don't expect an item by item answer to these questions but a POST getting into more detail on how i.v. plays into this type of trade would be great!
Set the stage for the trade in the next week or two (as I understand it):
Last earnings report Aug 21 so next report mid Nov (8wks).
Price action rules all -
NVDA in an uptrend at resistance, if breaks - buy Call.
NVDA bounces off resistance and forms double top and drops - buy Put.
Either way you can still play the rise in volatility.

Implied volatility - has consistently risen around 20% leading up to earnings and this rise starts about 6 wks before earnings. Now at 48% so can expect rise up to 70%.
Now I need help -
Strike price: Assuming we give the price action time to define itself over the next 1-2 wks, are there some general statements you can make about setting up a trade like this? For example: The at-the-money has the most "time value". I know that "time value" is composed of both time and i.v. Time will eat away at this "time vlaue"- that's bad. However increasing i.v. will increase this"time value"- that's good. In this type of trade should I buy the at-the-money to maximize the positive effect of increasing volatility? or perhaps buy an out-of-the-money such that the target price will bring the option to at-the-money?
Expiration Month: The time part of the "time value" does not deteriorate in a straight line and deteriorates faster as we approach expiration. I know I will sell just prior to earnings in Nov. (assuming price action has not pushed me out prior). If I buy Nov. then the rate of decline in "time value" would be greater than if I bought Dec. (and therfore affect me in a negative way faster). However if I buy Dec. I would be paying for time I never intend to use. Also would the rate of change in i.v. be less for the Dec. (vega) and therefore I would not get as positive an effect from increasing i.v.?
Follow up action: Would I give this type of trade a little more room to move knowing I am not only playing price but also i.v.? Once i.v. starts to rise can I assume it will continue to rise until earnings? If not then I should check both price and i.v. daily? If price action stalls (but doesn't go completely against me - small pull backs expected) but i.v. continues to rise then stay in the trade. But if i.v. also stalls when price action stalls then exit?

I could (and maybe should) go through all of these scenarios using the B-S calcuator. If the answer to these questions is trade specific then it will take the calculator. However if there are some generalization?

Thanks

L.V~

This is all part of the fun. Conducting your technical analysis is the easy part. Finding the right option is more complicated at first, but once you understand how different months/strike are more or less sensitive to different changes, it becomes easier. Try and think in terms of probability and which option is more/less likely to profit. This also helps to make the choice. Anyone else care to join in on this one???

To determine which option to choose and to see what might happen, you really should play with the B. S. Calculator.

Using NVDA as an example, I chose the $37.50 strike (Call) for Nov and ran the numbers as they are today. I also ran Dec $37.50 (Call). Again, using your example, I then increased the Volatility by 20% (44% to 64%), decreased the # of days by 30 and left the price alone.

So, using the B.S. Calc. numbers only, I come up with a 4.5% decrease for November (and a 45% increase for December.

Does anybody else agree with the Calculation ?


-Mark M.

See link below.
One of the traders at the Aramath hedge fund is down $5 Billion in a week. Now thats a loss!!

http://www.dailyfx.com/story/special_report/special_reports/How_a_Drop_in_Natural_1158758802266.html