This is a good rule. Don’t buy something when…
A) It’s trading at the top end of our risk ranges; and
B) It has an implied volatility discount (versus realized volatility)
“When A) and B) happens, you know what not to do. Don’t buy stocks,” Hedgeye CEO Keith McCullough said on The Macro Show recently. “You buy stocks when they’re at the bottom end of the risk range and they have an implied volatility premium.”
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(Note: Implied volatility is a measure of the market’s future volatility expectations for a particular asset class, teased out of investor positioning in options markets. A premium is when implied volatility exceeds realized volatility – i.e. the historical volatility of an asset. At its extremes, this implies fear. Conversely, a discount is when implied vol is lower than realized vol. At its extremes, this implies complacency.)
