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Posts Tagged ‘Strangle’

How to Contend With Historically Low Option Prices

Monday, March 19th, 2012

Option prices for the market in general (SPY) are lower than they have been for five years.  Maybe it is time to change from a strategy of selling short-term options (the strategy carried out at Terry’s Tips) to one of buying those options and hoping the market is more volatile than those low option prices would expect.

We will discuss that possibility today.

How to Contend With Historically Low Option Prices

Before discussing the situation of low option prices for most equities, I should comment on the continuing high option prices for Apple.  Implied Volatility (IV – the most important determinate of whether option prices are “high” or “low”) is about 40 for AAPL.  This means the market is expecting AAPL to fluctuate about 40% over the course of a year.

The high option prices for AAPL has meant that our calendar spread strategies has been quite successful of late (we move our calendar spreads to new strike prices as the stock moves higher).  We carry out two AAPL portfolios at Terry’s Tips – one gained 8% last week and the other gained over 20%.  The one that gained 8% has been operating for one month less than two years and is now ahead by 642%.  It is our most profitable portfolio by a large margin. 

Compare this 40 IV number for AAPL to IV of the S&P 500 tracking stock, SPY, which is called VIX.  It is less than 15, and briefly fell below 14 last week for the first time since I can remember.  This is extreme low territory (the mean average is about 20).

The IV picture for SPY gets even more interesting when you check out the Weekly options.  When VIX is calculated, the Weekly option prices are not included (only options with 8 or more days of remaining life or included).  IV for the SPY Weeklys is only 12.47.

Last week SPY rose $2.70 and the week before, moved by $3 in both directions during the week.  If you bought an at-the-money straddle or strangle using SPY Weeklys at today’s prices in either of those weeks, you would surely have doubled your money in a single week.

With SPY closing at $140.30 last Friday, you could have bought a 140 Weekly straddle (both a put and call at the 140 strike) for $1.80 or a strangle (the 141 call and the 140 put) for $1.33.  If the stock moved by at least $1.50 in either direction next week, either of those purchases should result in a gain.  SPY moves by that much in just about every week, even in quiet markets like we have been having so far this year.

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It is an interesting trade to try.  I plan to buy a few this week (in both my personal account and in one of the Terry’s Tips portfolios), just to test it out.  Of course, you should never risk money that you can’t afford to lose.

We have made 3 short videos which explain the 3-week results of our AAPL trading. The original positions were set out in an actual account carried out at Terry’s Tips.  The YouTube link is http://youtu.be/6J9KPuimyXk

The portfolio was updated in the Week 2 video -
http://youtu.be/e0B7_6e_5AE 

And finally, adjustment trades we made were displayed in this little video –
http://youtu.be/YC3d2NuX2MI  Be sure to enlarge it to full-screen mode so you can see the numbers. 
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Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips (including the two AAPL-based portfolios) and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself? 

I look forward to having you on board, and to prospering with you.

Terry

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