Our Self-Reinforcing Fixation on 52-Week Highs and Lows
Written by: Jared Woodard
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Every trader pays attention to 52-week highs and lows in the stocks they watch. As it happens, those trader tendencies have acted, historically, to create a sort of self-reinforcing feedback mechanism that generates usual price and option activity around those price levels. In a recent paper, "How the 52-Week High and Low Affect Option-Implied Volatilities and Stock Return Moments," three academic researchers look at the effect of 52-week highs and lows on the returns, statistical volatility, and option implied volatility of 295 U.S. stocks from 1996-2008.
Their findings are pretty remarkable. For example, implied volatility declines by about one volatility point when the stock is approaching the 52-week high, and the actual statistical volatility of returns decreases as well. Declines in volatility were also observed near 52-week lows, which is even more surprising since we typically associate price declines with increases in implied volatility.
Stocks that manage to break through those one-year highs or lows see their option implied volatility jump, on average, by a full point, and these effects typically last for several days.
The authors review major psychological theories to account for these phenomena, including anchoring theory, prospect theory, and investor attention. They find that Kahneman and Tversky's anchoring theory is consistent with both before-breakthrough and after-breakthrough activity patterns. In other words, it seems as though the fact that so many traders fixate on 52-week high and low price levels is the best explanation for why options markets and return volatilities act the way they do at those levels.
Last Chance to SIGN UP: On Saturday, July 21, the CBOE, Option Pit and OptionsProfits are hosting a full-day course, VIX - Everything from VIX to AAPL CLICK HERE FOR INVITE AND TO REGISTER.
Every trader pays attention to 52-week highs and lows in the stocks they watch. As it happens, those trader tendencies have acted, historically, to create a sort of self-reinforcing feedback mechanism that generates usual price and option activity around those price levels. In a recent paper, "How the 52-Week High and Low Affect Option-Implied Volatilities and Stock Return Moments," three academic researchers look at the effect of 52-week highs and lows on the returns, statistical volatility, and option implied volatility of 295 U.S. stocks from 1996-2008.
Their findings are pretty remarkable. For example, implied volatility declines by about one volatility point when the stock is approaching the 52-week high, and the actual statistical volatility of returns decreases as well. Declines in volatility were also observed near 52-week lows, which is even more surprising since we typically associate price declines with increases in implied volatility.
Stocks that manage to break through those one-year highs or lows see their option implied volatility jump, on average, by a full point, and these effects typically last for several days.
The authors review major psychological theories to account for these phenomena, including anchoring theory, prospect theory, and investor attention. They find that Kahneman and Tversky's anchoring theory is consistent with both before-breakthrough and after-breakthrough activity patterns. In other words, it seems as though the fact that so many traders fixate on 52-week high and low price levels is the best explanation for why options markets and return volatilities act the way they do at those levels.