I have 4 questions on Forward Volatility Strategy, can you someone please help
- ATM strike price has to be selected for this? what is the right time to do this strategy?
- Are we measuring the volatility everyday and taking position and closing position everyday based on +1 and -1 signals?
- Can we play forward volatility on weekly options? What is the ideal holding time for thsi strategy?
- What could be the best way to select underlying instrucments to play this strategy?
Please see the answers below
- It can be done on any strike price but the strike price needs to be same for near month/week and far month/week. Make sure the strike price you choose has good liquidity and open interest. This will ensure low slippage to enter and exit the trade.
- We need to measure the implied volatility and forward volatility every day or every minute. And based on the volatility values we decide to take the positions.
FV < IV: Long Far dated option and Short near month option.
You can either close the position when the volatility values change (FV>IV) or can reverse the positions. I prefer shorting near dated option and long on far dated option as you also get the advantage of theta in your favour. As theta decays faster for near dated option compared to far dated options.
- It can be implemented on weekly options as well. The ideal holding period varies from instrument to instrument, you can backtest the strategy and determine the average holding period for each of the instrument.
- The best way to select an instrument
Sufficient liquidity or OI in near and far dated options
No scheduled news or event expected from today to expiry of the far dated option
Significant absolute gap between FV and IV
Period fluctuations from in FV and IV, that is FV moving up and down from near dated option IV
Thanks