Forex Talking

In the world of derivative investments this is what leads to much confusion. It is much more straightforward to think in terms of the absolute change in the value of an investment rather than the percentage change. It is also considerably easier to represent profits or losses graphically if one uses an absolute measure.

The investment community is used to studying charts of stock prices over time like the one in Figure 1. These are known as time series charts. In these types of diagrams the horizontal axis is always time and the vertical axis is always a price. By buying at A and selling at B or by shorting at C and buying back at D, a profit is realized. To understand the volatility trade it is more instructive to look at a different
Representation of profit and loss as in Figures 2-4.

Figure 2 shows the value of a portfolio of one share of stock versus the price of the stock and as such is, of course, extremely simple. Figure 3 gives the change in the value of a portfolio of one share assuming the share was purchased at point A, i.e. at a price of $100. This chart represents the profit or loss (in absolute terms) on a long position in one share. In both these charts the horizontal axis is the price of the
Share and not time. As a result, the time sequence of the points A, B, C and D is lost. Note also that the gradient of the lines are 1 or 100%. These may seem like very obvious statements to make but it will become crucial later on to realise the importance of this apparently
Fig:
simple way of looking at profits and losses in terms of slopes of straight lines. Figure 4 gives the profit and loss to a short position in one share and obviously has a gradient of -1 or -100%.

Fig: