When Implied Volatility (IV) Rank is high, it provides us a better opportunity to sell premium. There are a number of strategies that we can use in order to take advantage of this high IV Rank. Today, Tom Sosnoff and Tony Battista discuss Strangles, Straddles, Jade Lizards and Butterfly spreads. The guys explain how each trade is structured, when the trades should be put, what we want to happen for each trade to be profitable and why each trade is used!

Tony: Thomas were back, my friend. Best Practices. What, when, why, how, who done it.
Tom: Not exactly- I’m not- Don’t get me wrong. I’m not upset about this opening.
Tony: The S&P’s down 9.
Tom: Yeah, I’m happy S&Ps are down 9.
Tony: The NASDAQ’s only down 11.
Tom: I needed NASDAQ down about 25ish, but let’s see what happens. They just whacked crude oil.
Tony: Yeah, we were a little early the first time in the overall markets ….
Tom: I kind of thought they might break them under 80 but done okay in there so far, so we’ll see what happens.
Tony: 79.72 in crude oil, yeah. Some survey-
Tom: Survey says?
Tony: Genscape Oil Report came out and then I think Goldman Sachs had said they lowered their estimates…..

Tom: I love the fact that everybody’s “lowering their estimates” on oil at $80. All right, whatever. Who cares? Let me just see. EWZ back to 38.55. I think we’re going to be just fine. I think the 38 puts are going to be a rip in there.
Tony: Yeah, the EWZ down 3 bucks.
Tom: Yeah, I think by the end of the day it’s going to probably close around 40 and all our stuff’s going to come in nicely. I love the risk-reward in there. You know, it’s not going to work out the way we want it to, but I love the risk-reward in there.
Tony: You still have a couple of days too, right? EWZ’s not till the end of the week.
Tom: Not till the end of the month.
Tony: I don’t know which ones you did.
Tom: EWZ?
Tony: You did a couple 4-day ones and then you-
Tom: Oh, yeah, I did a couple. You’re right. I sold some. You’re right. I sold the 49 calls and the 38 puts.
Tony: 38, 39 puts.
Tom: 39 puts and we’ll take all that off today, just so you know and let’s see how we did on the binary…… That’s the one I asked Case to do. I’ll bet you it all works out fine.
Tony: Yeah, we’ll see what the rank goes down to, yeah.
Tom: We’ve actually got a lot of stuff to do. It’s going to be good today. It’s going to be a good week. It’s going to be crazy good week, so I have to tell you this before. We have a guy coming on this week. He’s the head chef at GT Fish and Oyster.
Tony: Oh, great.
Tom: We’ve been there. We’ve been there together. We had a date once.
Tony: I saw that coming.
Tom: It’s a really nice fish place in Chicago.
Tony: Awesome fish….
Tom: There’s a lot of really good lobster. Lobster rolls have made their way out of the East Coast, but- Okay, I’m going to put a big but up there- but, I was in Portland, Maine, this weekend. My mom lives in Portland, Maine, now, so I went to Portland, Maine, to see my mom, and-
Tony: You went to go see a lobster roll. Your mom just happens to live there, but yeah, just go ahead.
Tom: Whatever, okay, and so I went to get lobster rolls and I bought some for my mom, my sister and her husband. No, no, no. We were having them for lunch.
Tony: Bringing me back something?
Tom: I got to like the Portland Lobster House, which is right on the water. The lobsters came in that morning. The lobsters were just cooked. I was watching them defrock them as I’m sitting there. This was the greatest lobster I’ve ever had in my life. This was the best lobster-
Tony: I’m sure.
Tom: I mean, I’ve had a lot of lobster rolls in my life. There’s nothing in Chicago, but I’m going to test this guy this week. I’m not telling him in advance. I’m going to test this guy with all my favorite lobster roll places. This was incredible. The best I’ve ever had.
The last time I was in Portland, Maine, another interesting observation. The clam roll- remember I told you that prices adjust, how efficient the market. The market some places-
Tony: You said, market price from that day.
Tom: The market’s not efficient with things like gasoline or coffee or any of that kind of stuff, but with clam rolls, the last time I was there, it was like 18.95 for a clam roll. Now, it’s 15.95. Prices move.
Tony: Yeah, markets move. Things change.
Tom: Markets move. I like it. Anyway, I had to tell you about that lobster roll.
Tony: How many did you take down?
Tom: I just had one because I was trying to- you know, I had a little chowder.
Portland, Maine’s a foodie town.
Tony: It’s actually very pretty, too, and-
Tom: It’s a pretty town but it’s a foodie town. Moof, boy, it’s good. Anyway, boy, it’s good.
Tony: How’s Mom?
Tom: Good.
Tony: Good. Did you give her my love?
Tom: Of course. Of course. She’s a little upset with you over a few things, but it’s okay. She’s okay. She’ll get over it.
Tony: Then things are normal between us. Then things are normal between us. If she had no problem-
Tom: She’s a little bit upset. You’ve said a few things about me that just may not be perfect. She gives you a lot of the benefit of the doubt. She lets you slide a lot.
Tony: Well, she knows your winnings, so it’s okay.
Tom: She goes, “How’s my portfolio doing?” I go, “Mom, I’m killing it for you.”
Tony: That’s what you should have told her.
Tom: I’m killing it.
Tony: You should see next time.I don’t know what’s wrong with that guy.
Tom: I scooped the bottom for you. I’m about to short the top for her right here.
Tony: Scoopy, scoopy.
Tom: All right. Are you ready?
Tony: I am, so let’s do it. Best Practices.
Tom: We’ve got a good segment. Best Practices. What the guys did is they said, “Listen, we’re going to put together a bunch of stuff, which we are going to do a bunch of strategy breakdown, what, when, why”- how come it doesn’t say where?
Tony: I guess that doesn’t matter, right?
Tom: “What, when, why,” whatever, it’s close enough.
Tony: No how?
Tom: Yeah. What, first, short straddle. Short strangle, I’m sorry. What, the simultaneous sale of an out-of-the-money call- but this doesn’t sound right for some reason. What, the simultaneous sale of an out-of-the-money call and put. When, preferably when IV rank is high. This allows us to sell much further out of the money option and collect a larger amount of credit using the same strikes as low IV rank. Also, we can profit if volatility contracts.
Let’s talk about strangles and- When we talk about Best Practices, all we want to do is just keep rehashing kind of the same old movie, because we get so many questions and the questions are consistent and let’s just keep hammering everything home so that everybody can almost can almost recite this stuff in their sleep.
Tony: I can still remember that last- that sentence doesn’t make sense to me then. This allows us to sell much further out of the money options. I agree with that. Or collect, oh, or collect a larger amount of credit using the same strategies as if we had a low IV rank. That makes sense that way. Sorry. The way you read it or the way I heard it.
Tom: All we’re basically saying is when IV rank is high-
Tony: We can use the same strikes and collect more or we can go further out or we can go further out and collect the same type of credit we would have received on strikes that are tighter at the money in a low IV, low IVs.
Tom: Yeah, it’s at your discretion and then you also have the ability to profit if volatility contracts. I’m trying to think of what the examp- I’ve got to wait because I can’t remember exactly the example, but I was going to give a vol example of real life. Anyway, why. Collected credit. Widening or break evens, higher probability of profit. Short data, we collected decay each day as long as the stock is within our break-evens and non-directional. Call and put deltas offset until the overall deltas change.
I think one of the neat things and one of the things that we’ve popularized in concepts- here, let me give you an example why this is so important. A young person that watched the show may be in his early 20s. He’s taking a finance class at some university and he writes me an email and he says, “You know, so I’m sitting class. I’m taking a class on options and derivatives and the first thing the teacher says before he starts the whole class on kind of, you know, he goes through puts and calls, and the first things he says is, “The reason we always buy options is because they have defined risk. The reason we never sell options is because we have undefined risk and that’s how you lose all your money.”” That’s how the class starts.
Here’s a kid that has been watching tastylive for 2 years and he goes, “You know,” and he doesn’t know what to say now, because now he’s sitting in the back of the room and he’s like, “I know a hundred times more than this professor knows.”
Tony: Yeah, there’s a contradiction here, yeah, sure.
Tom: “I know a hundred times more. I know everything there is to know about short strangles,” whatever he has been watching. He has been basically trading a thousand, 2,000 times a year for 2 straight years and he’s like, “And now I’ve got to listen to this guy tell me that he never saw a naked option-“
Tony: He has probably never made a trade, right?
Tom: Oh, no chance at all. “He never saw a naked option because somebody once told him that they lost their money,” and blah, blah, blah. That’s why this is so important because we’ve come so far and the whole Jeremy Siegel thing this morning, the same thing. We finally have to start to recognize, the whole world operates- I wasn’t just teasing you on that low on medium thing. That’s how it works. That is the fortune-telling business. What you do is, you sit down and you take a class in statistics from some gypsy but you don’t even know it is. That’s the whole thing, like you’re sitting there, like you’re taking-
Tony: Gypsy has a tie and he’s from JP Morgan, that kind of thing?
Tom: Yes, yes. You’re just taking a class on probabilistic outcomes. That’s all it is. You’re essentially getting your master’s degree, if you want to spend enough. She spends enough to get her Ph.D., so she has her Ph.D. on probabilistic outcomes. That’s all it is. She can recite to you the statistics of just-
Tony: I have body language, cold. I got it.
Tom: Of every event happening. It’s amazing. That’s what happens. That’s what happens. That’s the strangle. Let’s go to the next one.
The short straddle. Again, same principle, simultaneous sale of a put and call, assumption that the expected move is exaggerated. That’s when IV rank is high, plus 75 and we’ll take you right through the same list of things. Collect a large credit, be short theta. It’s again, it’s a very much a non-directional call. We’re indifferent to- we’re essentially indifferent to strategy. Let me to go the next one for a second. Why?
Playing for a large contraction in IV, possibly in earnings, looking for a little movement in the underlying. Again, none of that, we don’t know what’s going to happen. You just consistently going back to something that has a high statistical chance of success.
If you watched our show last week, we did 2 market measures on just kind of short premium and all the different advantages and disadvantages of how they work over time.
Tony: That was very good.
Tom: Yeah, very good stuff, and what the returns are and a bunch of people emailed and said, “Okay, awesome segments, but when I broke down the returns, the returns were actually relatively small compared to what I thought they were going to be,” and you’re 100% correct because what are you going to get paid for taking- if you used 10% of your capital, right, to make 9% a year on your capital-
Tony: On your full portfolio.
Tom: Of course. How is that a bad trade? With an 82% chance of success. See, everybody tends to forget that we live in an environment right now which risk-free dollars return zero, so if you don’t want to take any risk, you get zero. If somebody said to you, and again, we have to be, we have to put this into real perspective, because, like I said this morning, I don’t buy into any of the other- all the other probabilistic stuff doesn’t, all the other management stuff doesn’t make any sense to me.
Tony: Doesn’t work for you, right.
Tom: If you sit somebody down and say, “You’ve an 82% chance of using 10% of your capital to make 9% on your whole capital,” you’d probably say, “Done” in a heartbeat. If JP Morgan could present that case to me. Now they can’t because they don’t understand it, nor did they have the ability to execute that, but if they did, as a customer, I would probably say, “So you’re telling me that” – and I understand the risk, but, “You’re telling me that I have an 82% chance of making 9% on all my capital and give me a realistic expectation of what my risk is based on a 2-standard deviation move.” If you could articulate that, why wouldn’t everybody do that?
Tony: Sure.
Tom: If you told me on a 2-standard deviation move, you’re going to lose 4% of your overall capital, but you have an 82% chance of making 9% on your capital, I would say, “Done,” in a heartbeat, but we can’t articulate finance that way, so we’re stuck here listening to everybody else tell you that there’s a 50-50 chance the Dow’s going to 18,000, when it’s not true.
Tony: It’s a 5% chance. 95% chance….
Tom: This is the problem with it. This is the kind of logic that drives me crazy. This is absolutely horrible logic, drives me out of my mind, which is one of the problems that we have with not being able to articulate a very clean story, which is, if you’re going to tell me, if I have an 82% chance of making 9% on my portfolio and a 2-standard deviation move, in case the standard line goes against me, it’s going to cost me-
Tony: Explain what a 2-standard deviation move is and means, yeah.
Tom: If it’s a 3-standard deviation move, I’m going to lose 9%. If it’s a 2-standard deviation move, I’m going to- my whole portfolio. If it’s a 2-standard deviation move, I’m going to lose 4%. If you can articulate that to me, then I’m interested. That’s how finance should be. That’s the future of finance.
We’re going to do a long butterfly now just really quickly. I’m not going to spend a lot of time on this because it’s too much words, but we’ll archive it all, okay? A long butterfly, what is- buy 1, sell 2, buy 1. An example is buy 1 45, sell 2 50s, buy 1 55. When you’re expecting little move in the underlying, the short strike is at the money, and you’re expecting the stock to stay in a certain range. You want high IV in this example. Why? Because butterflies are generally cheap, meaning the risk potential is very low, so, however, if we create a broken wing butterfly, we’ll also have more risk than what we pay and we’ll get into that in a couple seconds, and here, this is a long butterfly. Again, Tony, I’m not going to spend a lot of time- What?
Tony: That’s a broken wing butterfly?
Tom: This is a broken wing because your skip strike, because assuming 95, 100, 105, it says 110, credit 25 cents and there’s all the statistics around the trade.
Tony: Again, you’re looking for little movement just like you would in a strangle that we used in the other example.
Tom: Then lastly we’ll do a Jade Lizard-
Tony: Like a high IV rank also.
Tom: Lastly we’ll do a Jade Lizard. What? It’s the sale of an out-of-the-money put and the sale of an out-of-the-money call spread. The reason for this is the put is richer as a stand-alone because of skew. The call-spread is richer as a stand-alone because of skew. Not richer against the radical, just on paper richer. Collecting a credit greater than the width of the call spread is preferred, so you have no risk to the upside. You only have downside risk, which is the total credit received, in this case it has to be at greater than a buck because otherwise you wouldn’t be- there’d be risk to the upside, so you get to subtract the buck minimum from the short strike and that’s your break-even. When? When price action’s weak. When? When IV rank is pumped. When you have a slight bullish assumption.
This may be something interesting for like EWZ right now, or this may be something interesting for [inaudible 00:14:30] one that has earnings today, one that had their binary event this morning, and then, why? Compared to sell your naked put, you collect more credit because you have the call spread and when collecting more-
Tony:
Tom: Right, and when you collect the money that’s greater than the width of the strike, there should [crosstalk 00:14:47]. Here’s an example. We used Jade Lizards almost exclusively when IV rank is high and cost basis is low. We used covered calls when IV rank is high, when cost basis is low, so there’s lots of different potential trades you could put on there. Which one has theoretically more risk? Probably in the covered call because the Jade Lizard brings in more credit. That’s all.
Tony: Sure.
Tom: You can be a little more selective strike-wise whatever it takes-
Tony: But the covered call would have higher profit potential [crosstalk 00:15:25].
Tom: We’ll stick to this whole segment. It’s too wordy to go through each word on a slide.
Tony. You loved it.
Tom: What?
Tony: You loved it, in other words.
Tom: Oh, my God, it’s the grace, ever, but, no, but we’ll stick it in the archives and we’ll let you go through it if you want to see any kind of-
Tony: It’s a nice refresher and that’s what we do on Best Practices is just go over refreshing for the newer viewers.
Tom: I didn’t spend a lot of time on it because I think there’s too much else going on today, so I want to come back for the opening because we have-
Tony: A bunch to do in Brazilian stocks and everything else like that, so we’ll take a-
Tom:
Tony: A bunch to do in our Brazilian stocks, right? PBR, EWZ. Take a look at all of them?
Tom: I always thought when it came to Brazil, we were going to have a lot more fun than adjusting some stock called EWZ. I saw that movie back a hundred years ago, “Blame it on Rio,” and between all the other stock, you’re thinking to yourself, “Damn, this Brazilian stuff looks like fun,” and what did we get out of it?
Tony: EWZ.
Tom: PBR and EWZ
Tony: Take a quick break. We’ll be back in 90 seconds. This is tastylive live.