Adjusting To The Current Market Volatility In Putting Context Behind Your Options Strategy, I went over several steps that you should go through before entering an options position. Of course, you’ll have to take into account the current state of the market. For example, you’ll want to identify if the broad market is in a bullish or bearish trend and if volatility is relatively high or low. One way to gauge market volatility is by looking at the 30-day at-the-money implied volatility of the SPDR S&P 500 ETF, which is an ETF that tries to track the performance of the S&P 500 Index. On Tuesday 10/13/2014, the 30-day at-the-money implied volatility of the SPDR S&P 500 ETF (SPY) was 20.34%. Now, implied volatility is expressed in annualized terms…however, when expressed in daily volatility terms it’s 1.47%. Which may or may not seem like a lot to you. But in the beginning of the month, the 30-day at-the-money implied volatility of the SPDR S&P 500 ETF (SPY) ETF was 14.7%…expressed in daily volatility terms that’s 0.92% Clearly, we’ve seen a spike in market volatility. But what does that mean to you and
what are the do’s and don’ts of trading a volatile market? First, prices move faster. In terms of options trading, that means bid/ask spreads can widen. Which translates to a greater chance for slippage. When things are moving fast, sometimes investors will try to chase…in fear of missing out, they will buy at the offer price. When it’s not working they’ll sell on the bid, in fear of losing more money. Two fears mentioned, the fear of missing out (greed) and the fear of losing money. When market volatility rises these emotions become a lot more common. If execution is critical, how can we combat faster markets and wider bid/ask spreads? Well, if speed is something you lack…then trading outright calls and puts may be too difficult. One way to limit losses, is to position yourself smaller...which allows room for error caused by slippage. Also, market orders in this environment are probably not suitable for the average option investor. In a faster market, chances of you getting chopped up quickly is greater. By placing limit orders, you’ve defined the price you’re willing to get filled at and have drawn some kind of line in the sand. If you don’t get filled right away or miss the opportunity… don’t stress out about it. Focus on the next opportunity…by getting on yourself for missing a trade, you are only frustrating yourself and becoming overly emotional. You want to try to keep your emotions in check as much as possible. Volatile Markets Are For Traders Not Investors Because things move quicker, you’ll need to be more nimble. If something moves in your favor, consider piecing out and taking profits. If for whatever reason, you are not the nimble type…consider staying in a cash position until your ideal market conditions arise. A cash position is a luxury we have as individual investors. A financial broker/advisor needs you to be in the market, in order for them to generate larger fees…however, when you’re doing this for yourself..the goal is to make money for yourself not filling their pockets. Outside of wider bid/ask spreads and faster market conditions, there is another thing that happens…options tend to get more expensive. However, it doesn’t happen uniformly. Markets tend to see higher volatility when stocks sell off vs. when they trade higher. Think about it, most institutions are long stocks and the stock market. Through the use of
options they can hedge their stock position by applying a number of different strategies. Two of the most common hedging strategies are buying puts and selling calls. For example, If an individual investor had IBM stock and feared that it might sell off…they could buy puts. If you read Putting Context Behind Your Options Strategy, you’d know that a combination of long stock and a long put is a synthetic call (also known as a married put). This allows for the position to have defined risk. Another common strategy is selling calls against a long stock position. This is also known as a covered write or a synthetic short put. By selling calls against your long stock position you’re collecting a premium which gives you a slight cushion against a downside move…however, it does not offer full protection. The common practice of selling calls drives implied volatility lower as we move farther OTM….on the flip side, option investors looking for cheap options will pay up for OTM put options. This makes the equidistant OTM puts more expensive than the equidistant OTM calls. This is what is referred to as skew. For institutions or large individual investors who have a very diversified portfolio… they make look to hedge by using SPY options or some other index. Of course, savvier option traders can use the VIX or some other volatility related ETF/ETN. Now, just because volatility is rising…doesn’t necessarily mean that higher option volatility is justified. In many cases, it’s over exaggerated and it creates opportunities to sell option premium.. So if paying for protection is more expensive, what can one do to hedge? Well, there are two approaches that I like when buying premium. Now, if you don’t have a stock position and are speculating on a stock…you can sell premium via option spreads (or even do butterfly spreads). The key is to put your strategy into context. OptionSIZZLE believes that you should be strategic at all times. Part of every trading plan should include flexibility…the ability to make adjustments to the present market conditions. The SPX Method course is a step by step approach, with parameters that look to enter high probability opportunities… no matter the conditions… and believe me, there are adjustments we make to the strategy as volatility conditions fluctuate from low to high.
Furthermore, what was working for you in the past…might not work under the present volatility environment. However, that doesn’t mean that can’t be successful. You just need to make tweaks along the way. Now, If you’re long and concerned about a market correction here are some ideas:
Reduce your position
On your reduced position, take advantage of potentially expensive calls and sell them
against your stock
You can use the premium from the calls sold to buy puts…which will help reduce your
long exposure, this is referred to as a bull collar or synthetic bull call spread.
Look to take advantage of the higher implied volatility by selling puts to either get long
at lower prices or to just collect the premium Of course, picking market tops and bottoms is nearly impossible for anyone…you might have a hunch that a stock is on the verge of turning…only to get whipsawed around by the volatility. Everyone is a genius in a bull market. Now it’s a battle of 5 years of buy the dips works vs buy the dips is over. Who wins ? — Mark Cuban (@mcuban) October 13, 2014 If trading volatile markets is not your specialty…now is not the time to play “hero.” Only time will tell whether this is a correction or the start of something bigger. For individuals, like myself, the increase in market volatility is a blessing. You see, when market volatility is low…opportunities tend dry up and there isn’t enough “juice” (option premium) to justify being an option seller…whereas, in volatile markets, you’re paid handsomely to take on the risk. Now, it’s also worth noting…that if what you are doing isn’t working…it doesn’t mean you should abandon everything and style drift. In many ways this goes back to volatility and how it affects the way options are traded. There are plenty of opportunities out there…however, the key is to be flexible and patient. By the way, have you made any changes to your current plan? If so, I’d love to hear from you. I’ll be hanging out in the comments section below.
Hi I’m Josh, and I’m a finance guy. I cut my teeth in the markets on the Chicago Mercantile Exchange, so I saw firsthand how the “sausage was made” – and it usually wasn’t pretty. Because I quickly realized that fund managers only care about getting their fee's first even though 95% of them underperform the overall market. That didn’t sit right with me, so I left that world – And I discovered how to use my financial know-how to empower the little guy by using high-powered investing techniques – including the only “real time” market indicator the pro’s use to spot future price direction. Now I’ve shared my message with over 129,000 people like you, and everyday investors have suddenly started making money in the market for the first time. Make sure you visit http://www.OptionSIZZLE to access your FREE report and eBook that will teach you how to trade options successfully to help you create wealth, freedom & options for you and your family.