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Posts Tagged ‘IV Advantage’

Closing Out the eBay Spreads

Friday, January 18th, 2013

Closing Out the eBay Spreads 

All of the shot options could be purchased for $.01 (with no commissions due at thinkorswim) so I bought them all back. 

The earlier net cost I reported was inaccurate (in my note to subscribers, I recommended buying 10 of the 50 put spreads but I used 20 in the calculations).  The net investment after commissions was actually $3417.50 rather than the $3942.50 reported. 

This is what I sold the remaining Feb-13 options for (after subtracting the $.01 repurchase of the short options): 

10 Feb-13 50 puts for $.26 = $260 

20 Feb-13 52.5 puts for $.80 = $1600 

20 Feb-13 55 calls for $.90 = $1800

10 Feb-13 57.5 calls for $.23 = $230 

Commissions on sales – 60 x $1.25 = $75

Net received = $3815 

Cost = $3417.50 

Gain = $397.50, or 11.6%

While an 11.6% gain after commissions isn’t bad for a couple of days, it was far less than we expected going in.  The big disappointment came from how much implied volatility (IV) of the February options fell after earnings were announced.  I had estimated that it would fall from 35 to 33 (its number when there was a full month remaining in the January options).  Instead, IV tumbled all the way to 25 so that the February options were trading at prices much lower than we expected. 

Several subscribers have written in saying they took off the spreads on Thursday before IV had tumbled so much, and they made an average of about 24% after commissions. 

Knowing that IV will fall so much can be helpful in the future.  There are at least two things we might do differently.  First, we could buy longer-term options for the long side.  IV for the April options only fell 3 points after expiration.  While this would require a much larger investment, the net gain should be much higher. 

The other possibility would be to sell next-month iron condors just before the earnings announcement.  After the announcement, when IV for those options crashes it should be possible to close out the spread at a nice gain (not waiting until expiration).  The risk should be quite low here. 

Next week, in our Terry’s Trades portfolio, we will be placing calendar spreads in advance of the Starbucks earnings announcement on Thursday.  IV for the Weeklys we will be selling is 45 while the Feb-13 options carry an IV of 28 but the April options are only at 24 so they are likely to fall not nearly so far. 

In addition to placing the calendar spreads with April as the long side, I will personally sell an iron condor in the Feb-13 series to see how that compares to the calendar spreads.

 Of course, I will report back to let you know how each of these strategies perform.

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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I have been trading the equity markets with many different strategies for over 40 years. Terry Allen's strategies have been the most consistent money makers for me. I used them during the 2008 melt-down, to earn over 50% annualized return, while all my neighbors were crying about their losses.

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