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Posts Tagged ‘at-the-money’

Volatility’s Impact on Option Prices

Monday, April 28th, 2014

Today I would like to talk a little about an important measure in the options world – volatility, and how it affects how much you pay for an option (either put or call).


Volatility’s Impact on Option Prices

Volatility is the sole variable that can only be measured after the option prices are known.  All the other variables have precise mathematical measurements, but volatility has an essentially emotional component that defies easy understanding.  If option trading were a poker game, volatility would be the wild card.

Volatility is the most exciting measure of stock options.  Quite simply, option volatility means how much you expect the stock to vary in price. The term “volatility” is a little confusing because it may refer to historical volatility (how much the company stock actually fluctuated in the past) or implied volatility (how much the market expects the stock will fluctuate in the future).

When an options trader says “IBM’s at 20” he is referring to the implied volatility of the front-month at-the-money puts and calls.  Some people use the term “projected volatility” rather than “implied volatility.”  They mean the same thing.

A staid old stock like Procter & Gamble would not be expected to vary in price much over the course of a year, and its options would carry a low volatility number.  For P & G, this number currently is 12%.  That is how much the market expects the stock might vary in price, either up or down, over the course of a year.

Here are some volatility numbers for other popular companies:

IBM  – 16%
Apple Computer – 23%
GE – 14%
Johnson and Johnson – 14%
Goldman Sachs – 21%
Amazon – 47%
eBay – 51%
SVXY – 41% (our current favorite underlying)

You can see that the degree of stability of the company is reflected in its volatility number.  IBM has been around forever and is a large company that is not expected to fluctuate in price very much, while Apple Computer has exciting new products that might be great successes (or flops) which cause might wide swings in the stock price as news reports or rumors are circulated.

Volatility numbers are typically much lower for Exchange Traded Funds (ETFs) than for individual stocks.  Since ETFs are made up of many companies, good (or bad) news about a single company will usually not significantly affect the entire batch of companies in the index.  An ETF such as OIH which is influenced by changes in the price of oil would logically carry a higher volatility number.

Here are some volatility numbers for the options of some popular ETFs:

Dow Jones Industrial (Tracking Stock – DIA) – 13%
S&P 500 (Tracking Stock – SPY) –14%
Nasdaq (Tracking Stock – QQQ) – 21%
Russell 2000 (Small Cap – IWM) – 26%

Since all the input variables that determine an option price in the Black-Scholes model (strike price, stock price, time to expiration, interest and dividend rates) can be measured precisely, only volatility is the wild card.   It is the most important variable of all.

If implied volatility is high, the option prices are high.  If expectations of fluctuation in the company stock are low, implied volatility and option prices are low.  For example, a one-month at-the-money option on Johnson & Johnson would cost about $1.30 (stock price $100) vs. $2.00 for eBay (stock price $53).  On a per-dollar basis, the eBay option trades for about three times as much as the JNJ option.

Of course, since only historical volatility can be measured with certainty, and no one knows for sure what the stock will do in the future, implied volatility is where all the fun starts and ends in the option trading game.

A Useful Way to Think About Delta

Monday, April 23rd, 2012

This week we will start a discussion about the “Greeks” – the measures designed to predict how option prices will change when underlying stock prices change or time elapses. It is important to have a basic understanding of some of these measures before embarking on trading options.

I hope you enjoy this short discussion.

A Useful Way to Think About Delta

The first “Greek” that most people learn about when they get involved in options is Delta.  This important measure tells us how much the price of the option will change if the underlying stock or ETF changes by $1.00. 

If you own a call option that carries a delta of 50, that means that if the stock goes up by $1.00, your option will increase in value by $.50 (if the stock falls by $1.00, your option will fall by a little less than $.50).

The useful way to think about delta is to consider it the probability of that option finishing up (on expiration day) in the money.  If you own a call option at a strike price of 60 and the underlying stock is selling at $60, you have an at-the-money option, and the delta will likely be about 50.  In other words, the market is saying that your option has a 50-50 chance of expiring in the money (i.e., the stock is above $60 so your option would have some intrinsic value).

If your option were at the 55 strike, it would have a much higher delta value because the likelihood of its finishing up in the money (i.e., higher than $55) would be much higher.  The stock could fall by $4.90 or go up by any amount and it would end up being in the money, so the delta value would be quite high, maybe 70 or 75.  The market would be saying that there is a 70% or 75% chance of the stock ending up above $55 at expiration.

On the other hand, if your call option were at the 65 strike while the stock was selling at $60, it would carry a much lower delta because there would be a much lower likelihood of the stock going up $5 so that your option would expire in the money.

Of course, the amount of remaining life also has an effect on the delta value of an option.  We will talk about that phenomenon next week.

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.

_ _ _

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

The portfolio was updated in the Week 2 video – 

And finally, adjustment trades we made were displayed in this little video –  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 (, 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.


Finding an Implied Volatility Advantage

Monday, August 15th, 2011

This market has surely been a crazy one. It has been a difficult one for many of our portfolios that do best if the market is flat rather than gyrating all over the place. But right now, option prices are such that new spreads promise to do exceptionally well, especially if the market manages to settle down a bit.

Today I would like to discuss an important feature of buying calendar (or diagonal) spreads.

Finding an Implied Volatility Advantage


When market professionals talk about the Implied Volatility (IV) of a particular stock or ETF, they are referring to the at-the-money current-month put and call options for that underlying instrument.

While it makes total sense that every option for a particular underlying should have the same IV, in reality it is usually not the case.  Some options are more expensive than they “should” be and others may be cheaper than they “should” be.

When I was a market maker on the CBOE, one of my favorite tactics was to find discrepancies in IVs of options on the same underlying, selling the “over-priced” options and buying the “under-priced” options.  I would try to maintain a neutral net delta condition at all times so I didn’t care whether the stock went up or down while I waited for the market to correct itself and move the IVs of both sets of options closer to parity.   (I surely wasn’t alone in using this tactic, as it was, and still is, one of the most widely-employed strategies on the floor.)

The 10K Strategy that we carry out at Terry’s Tips involves buying LEAPS (or other longer-term options) and selling short-term options (sometimes Weeklys) against them.  If the long and short sides of the spread are at the same strike, it is called a calendar spread, while if they are at different strike prices, it is a diagonal spread.

In the best of all possible worlds, we would seek out underlying stocks where the LEAPS carried a lower IV (so they were “cheaper”) than the IV of the short-term options (which were more “expensive”).  Whenever we enjoyed this difference in IVs, we know that we have an IV Advantage.
Most of the portfolios that we carry out at Terry’s Tips use SPY as the underlying, in spite of the fact that there rarely is an IV Advantage for that ETF.  It is more likely to be found for individual company options, especially when there is a rumor or earnings announcement coming soon, as short-term options often see unusually high IVs in anticipation of such events.

At the present time, the short-term options for SPY carry a higher IV than do longer-term options.   The August options that expire this Friday carry an IV of 36 while SPY options expiring in January 2013 have an IV of only 28.  This would be a perfect time to place the kind of calendar spreads that are the basis of our most popular strategy.

While having an IV Advantage stacks the deck in your favor, it should not be used as a sole determinate in choosing an underlying instrument to trade options on.  It is possible to make good returns with the 10K Strategy when you don’t enjoy an IV Advantage, but it is extremely helpful whenever option prices make it possible.    

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