Our preference is to use High Implied Volatility Strategies but Implied Volatility (IV) is currently low. The S&P 500 has an Implied Volatility Rank (IVR) of 5% and an IV Percentile of 10%. The alternative, obviously, are Low Implied Volatility Strategies. This makes even more sense considering that we know IV is mean reverting. Debit Vertical Spreads are one choice for low IV environments. What is the best way to use them in such situations and why?
Generally, Debit Vertical Spreads have positive Vega. They benefit when IV increases as it reverts to the mean. Set up properly they also benefit from Theta (time decay). A graph of a Debit Put Spread consisting of a long in-the-money Put (ITM) and a short out-of-the-money Put was displayed. The graph included the P/L versus the stock price, the actual spread, debit/credit, risk/reward and Probability Of Profit (POP).
Should we shift the strikes up, our probability of profit rises due to the decrease in max profit and increase in our max loss. The downside is we are not benefiting as much by the increases in IV. An example of a Debit Call Spread was displayed. As with the Debit Put Spread, the less the max profit and greater risk taken the greater the POP.
For more information on Debit Spreads see:
Tasty BITES from September 30, 2015:"Credit and Debit Vertical Spreads"
Options Jive from April 8, 2016: "Strategy Comparison | Vertical & Diagonal Spreads"
Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the important takeaways and a better understanding of how and why to use Debit Vertical Spreads in a low IV environment.
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