Best Practices

Top 3 Strategies for Today’s Volatility Environment

| May 9, 2016
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    Best Practices

    Top 3 Strategies for Today’s Volatility Environment

    May 9, 2016

    We like to sell option premium in high implied volatility (IV) and high implied volatility rank (IVR) environments. Despite the recent move down, many stocks still have low IV levels. Since we also firmly believe in staying engaged in the markets we decided to look at the three top strategies for the present low IV/IVR scenario; namely, long Vertical, Calendar and Diagonal Spreads.

    We would look to employ such strategies when IVR is in the 10-15 range and the volatility difference from front to back months is relatively small. The latter requirement is only necessary if we are using Calendars or Diagonals. When we buy a Vertical Spread we want our long end to be in-the-money (ITM) and our short end to be out-of-the-money (OTM). This takes advantage of Theta (time decay). We manage winners more aggressively and seek to pay slightly more than ½ of the width of the spread to increase our probability of profit (POP). An example was provided.

    A slide of a Calendar Spread setup of selling the front month option and buying the back month option was displayed. The slide showed that a Calendar Spread can be directional or neutral depending on the strike placement and that using a low POP, low risk strategy requires a need to set realistic profit targets. A previous study of SPY at-the-money (ATM) Put Calendar Spreads (1022 occurrences) when the VIX was below 15 was displayed. The study and table results included the percentage of winners, average P/L per trade and biggest loss on Calendars that were held to expiration, managed at 25% and managed at 50%. The study showed that managing winners aggressively improved our POP above 50% with a net positive result.

    A slide of a Diagonal Spread setup of selling the front month OTM put and buying the back month ITM put (if bearish) was displayed. If bullish you would sell the front month OTM call and buy the back month ITM. These are also known as a Poor Man’s Covered Put and a Poor Man's Covered Call. The Diagonal combines some of the best from the Vertical and the Calendar into one trade with lower costs.

    For more information on the strategies mentioned here see:

    Watch this segment of “Best Practices” with Tom Sosnoff and Tony Battista for a great refresher course of the top 3 strategies (Calendars, Diagonals, Verticals) in a low volatility environment and a great reference guide on when to use them.

    This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.

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