If you happened to catch this week's live episode of The Long & Short of It, you'll remember that Dylan and Vonetta discussed how the English language keeps adding new words to its lexicon by mashing multiple words into two or three letter combinations so ideas can be expressed in 140 characters or less. Case in point: the portmanteau du jour, “Brexit.”
The long and drawn out debate over Great Britain leaving the European Union (i.e., Brexit) will be put to a vote tomorrow. It's nearly impossible to watch or read any news without coming across some poll regarding a possible Brexit.
Dylan wants to know how a tastytrade polliwog, such as himself, can capitalize on Thursday’s vote. He correctly points out future fear is overpriced, causing Tom to display a proud father-like smile. Still, Dylan wanted guidance on what products specifically he could trade for this particular binary event.
Tom explained that he has already sold premium around FXE (currency ETF for the Euro), the British Pound and the Euro. He has also closed out many of those positions as volatility fell. As Tom explains, trading binary events is not about correctly picking market reaction. It is about trading when the marketplace will reprice that event.
Last week, volatility moved higher by nearly 30% because of the uncertainty surrounding Brexit. This week, volatility is giving back some of that move as Brexit looks more unlikely. And that is where tastytraders can make their trades.
We cannot predict markets or how they will respond to events. What we can mathematically rely upon is the mean reverting characteristic of volatility. As volatility moves up, reflecting pent up fear, premium becomes very overpriced. Eventually that fear subsides, reverts to its mean and with it, premium collapses. We want to sell that premium into high volatility then buy it back as volatility erodes.
Josh Fabian has been trading futures and derivatives for more than 25 years.
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