Reminiscences of an Option Trader: VIX = Knicks
OK, here is my attempt to come up with an analogy to these VIX offshoot products, with the hope that it dissuades most from using them.
Let's say there was a contract that estimated the total number of Knick wins in their next 30 games. I'll call it the "KNIX." And let's say the KNIX was always rolling, that is once they play a game, it just rolls to estimate the win total for the following 30 games, and does not count the last one. Past performance matters of course, as it will color that estimate, the same way past option performance colors estimates for the near future.
Now let's say we list a KNIX future, with an expiration date of March 17th. Just humor me for a sec, and assume they still have 30 games left from that date on.
If you play the KNIX, you are guessing today as to what the "market" will think of the Knicks; not today, but from a moment in time 65 days from now. Of course you have some basis to make that "guess," but it is just that, an educated "guess."
Now how about some KNIX options that expire March 17th? You are not only betting on their win "estimate" on that snapshot date, but also the "streakiness" between now and then, for a streakier team will trade at a higher volatility than a more consistent one. In other words, this KNIX future would probably trade at about 12 now, based on their early season performance, but KNIX 14 calls and KNIX 15 calls would have more value than those in an equally bad, but more consistently bad, team (say the HAWX 14 and 15 calls).
Sounds confusing, right? Well now substitute VIX for KNIX, and translate all this from something relatively easy to understand, NBA win estimates, to something much more difficult, option pricing. And not just option pricing, but guessing as to option pricing on some future date.
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