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Options Trading Based on the Forecasting of Volatility Direction with the Incorporation of Investor Sentiment

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  • Her-Jiun Sheu
  • Yu-Chen Wei
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    Abstract

    Using options price data on the Taiwanese stock market, we propose an options trading strategy based on the forecasting of volatility direction. The forecasting models are constructed with the incorporation of absolute returns, heterogeneous autoregressive-realized volatility (HAR-RV), and proxy of investor sentiment. After we take into consideration the margin-based transaction costs, the results of our simulated trading indicate that a straddle trading strategy that considers the forecasting of volatility direction with the incorporation of market turnover achieves the best Sharpe ratios. Our trading algorithm bridges the gap between options trading, market volatility, and the information content of investor overreaction.

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    Bibliographic Info

    Article provided by M.E. Sharpe, Inc. in its journal Emerging Markets Finance and Trade.

    Volume (Year): 47 (2011)
    Issue (Month): 2 (March)
    Pages: 31-47

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    Handle: RePEc:mes:emfitr:v:47:y:2011:i:2:p:31-47

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    Web page: http://mesharpe.metapress.com/link.asp?target=journal&id=111024

    Related research

    Keywords: HAR-RV model; investor sentiment; market turnover; options trading; volatility forecasting;

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