Sheldon Natenberg and Timothy Withers Discuss Volatility at CBOE Risk Management Conference

The 2nd Annual CBOE Risk Management Conference kicked off today with a session led by Sheldon Natenberg and Timothy Weithers who are the Co-Directors of Education at Chicago Trading Company.  The session title is Volatility Primer and Option Risk Measures.  Natenberg is also well known as the author of Option Volatility & Pricing:  Advanced Trading Strategies and Techniques which is a must own book for any option trader.  The duo covered a wide variety of topics such as illustrating what volatility means, volatility characteristics, and dynamic hedging strategies.

Natenberg gave the audience an overview of option pricing factors with a focus on volatility.  I cannot think of anyone that if comparable to him in the ability to illustrate and explain volatility.   He showed how traders can answer the question, “Is the current implied volatility of option prices accurate relative to what I see going on in the market?”  He illustrated skew by asking the rhetorical question of the audience, “How many of you think the market drops faster than it moves higher?”  This market characteristic explains why put pricing is often higher than comparable call pricing.  This higher put pricing will correlate with a higher implied volatility and the result is what we refer to as skew.

Tim followed Sheldon to focus more on the option greeks.  Tim discussed his transition from a college professor at the University of Chicago to working as educator of option traders.  He actually made an interesting statement in that many institutions he speaks to do not necessarily concentrate too much on the option greeks when considering an option trade.   He isolated each of the greeks and using SPX pricing demonstrated how changes in the underlying market, passage of time, or a change in volatility will impact an option’s premium.

Natenberg wrapped up the discussion by demonstrating how to capture volatility value through talking about the basics of volatility trading.  He showed this through a basic demonstration of delta hedged trading.  As the stock price moves higher or lower the hedge starts to disconnect and when this occurs there will be a small profit based on the unhedged position.   He refers to this as dynamic hedging where profits are captured through rehedging the position.  If there is more volatility in the underlying stock price changes relative to the implied volatility priced in the option when it was purchased.