The tasty BITES segment from June 1st, 2016, “Uncorrelated Trading”, stressed the importance of choosing underlyings that are uncorrelated. We like to be short option premium in high Implied Volatility (IV) environments but the only high IV area seems to be the metals and the metals are highly correlated. What strategies can we use in this low IV environment while still using underlyings that are not highly correlated?
Calendar Spreads are a possible answer. We sell the near term option and buy one with more time until expiration. Calendars provide diversification for a typical tastylive account that is short premium and give us an added bonus in that besides benefiting from theta (time decay) they also benefit from an increase in IV. That’s great for our typical portfolios that are short Vega. Our study was conducted in the SPY (S&P 500 ETF) from 2005 to the present. We bought Calendar spreads everyday that were comprised of a short the at-the-money (ATM) put closest to 45 days to expiration (DTE) and long the ATM put in the next monthly cycle. We then compared these spreads when initiating them in a low IV environment, defined by the VIX being below 15, versus all IV environments. We also tested two different levels of managing winners.
A table of the results compared the percentage of winners, average P/L per trade and biggest loss on holding the Calendar Spreads to expiration, managing at 25% of the initial debit (or holding to expiration) and managing at 50% of the initial debit (or expiration). Managing winners turned the trade from a scratch to a winning trade in all environments and the average P/L per trade was highest at 25% management. A second results table putting on the Calendar spreads only when the VIX was below 15 was displayed. The table showed that waiting for low IV increased the success rate and the average P/L per trade dramatically, sometimes by 300%.
For more information on Calendar Spreads see:
Best Practices from April 27th, 2015: “Calendar Spreads”
Market Measures from December 30th, 2015: “Calendar Spreads | A Hedged Strategy”
Best Practices from May 9th, 2016: “Top 3 Strategies for Today’s Volatility Environment”
Watch this segment of Market Measures with Tom Sosnoff and Tony Battista for the very important takeaways and the results of our study on Calendar Spreads in lower IV environments and when managing our winners.
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.