High Volatility means Huge Credit Spreads

With what has occurred over the last week in the markets we have some really high volatility, which means very high premiums for credit spreads. So what does this mean for the conservative trader?

Do not be greedy!
The first thing everyone that trades spreads thinks of is great I can make more money on my spreads, I can find more credit spread trades that meet the criteria! However there is one problem. There is a reason that the premiums are more - the risk is more! A high volatility means that the stocks move more, the noise is louder, and weak supports and resistance mean almost nothing. You are risking a big move against your position which can have very disastrous results on your profits and your overall performance.

The conservative trader will do one of two things - 1. Get out of the market until things settle down a bit or 2. move your positions so you are still getting only a 10% rate of return (ROR) on your credit spreads. What this does is brings your trade positions above or below the noise by enough that you can get out of the trade if it moves against you.

Right now with how much the markets are moving and the government is still playing causing much more uncertainty, which in turn raises volatility, I personally closed my credit spread positions and I am waiting. Will I miss out on the really high volatility high premiums? Yes probably but I will still be able to get in one the higher than last year premiums and find more trades in a week or two than I have been when volatility was low.

credit spreads, option trading, volatility

Beginning Option Trading: Selling Calls Against Stock

This was such a great explanation of selling calls against stock I just had to post it for you here. It comes from a fellow forum poster Prohobo owner of Market Preview

Selling calls against stock come with many names:

“Covered Calls” (calls are sold against the stock and therefore “covered” by the stock purchase)

“Buy Writes” (Sometimes used as on bothsides of the trade - either buying the stock and writing the option OR buying the option and writing the stock. I have heard brokers for decades use this interchangeably (rightly or wrongly) synomous with Covered Calls.

“Over Write” or “Call Writing” (Usually the stock is already owned and the calls are sold against an existing stock position).

At the end of the day - it doesn’t mater WHAT you call it. All you are doing is selling calls against a long stock position.

The trick is not only picking stock direction, but picking the right strike to sell and for the best premo.

There are several ways to aproach it, but no correct way.

Some traders look for what is known as STATIC RETURN. This is simply the PREMIUM over parity (extrinsic value) (AKA: Juice, Time Value, Premium, etc.). Simply EVERYTHING over intrinsic value. This value is then divided by the stock price to get static return. If the stock were NOT to move the return value would be X% vs. the underlying price.

Example:

Stock XYZ is trading $101.00

The 100 level call is trading $9.00

The EXTRINSIC VALUE of the 100 call is $8. Since they are 1 dollar in-the-money (ITM).

If you bought the stock at 101 and sold the call at 9.
If the stock closed at 101 on expiration (unchanged from today). The static return would be 8% (8/101). If this was done for on an option that expires in 60 days (2 months). Your annualized model would be 48% annualized static return on the strategy. (8 * 6).

This doesn’t mean that you will get 48% return, the model is just measuring static return.

Another way to look at it is that if the stock move up ANY AMOUNT your return is capped at 8% for that time perioud.

Additionally you have a 8% downside buffer to break even.

A easy way to look at it - selling the 100 level call for 9 is like pre-selling the stock at 109, after you just bought it for 101. A $8 profit - if the stock closes at 101 or higher.

———————–
Some traders look for short term forecasts as to stock direction. Let’s say your expectation was for the stock to move up to 110 in 2 months, which call would be best to sell based on your expectation.

95 Call for $12
100 Call for $9
105 Call for $7
110 Call for $5

The answer is simple: The 95 call is like selling stock at $107, the 100 call is like selling stock at 109, the 105 call is like selling stock at $112, the 110 call is like selling stock at $115.

However - lets look at the premium levels.

The 95 call only has $6 of premium (12-(101-95) or static return of 6% with NO upside potential. Max return of 6%

The 100 call only has $8 of premium (9-(101-100) or static return of 8% with NO upside potential. Max return of 8%

The 105 call is ALL premium $7 since it is out-of-the-money OTM a static return of 7%, but an upside delta return of an additional $4 (105-101). Net max return of $11 or 11%.

The 110 call is ALL premium $5 since it is OTM a static return of 5%, but has an upside delta return of an additional $9 (110-101). Net max return of $14 or 14%.

As you can see the 105 and 110 call have less premium than the ATM (at-the-money) 100 call ($8 of juice). However, since they are OTM they have the added benefit of not off-setting HARD DELTAS for several points - giving you a bigger return if you are RIGHT about direction.

The 100 call is the safe bet - it gives you the biggest downside buffer and highest static return. If you want the added horse power of HARD DELTAS then the 105 or 110 call is the choice.

As you can see it all depends what your expectations and perpensity for risk is.

Remember - if your calls are getting called away - your are MAKING money. It is a GOOD THING. Only fools who have covered-calls on do NOT want to be called. They haven’t figured out the math yet. Believe me - I have heard even a couple of retail NOB brokers say - you don’t want to be called away on covered calls you are just giving away upside. Then I remember why they are a broker and not a trader. (Other than tax purposes - you really do want to get called away - the earlier the better).

covered call, stock option trading, writing calls

A basic understanding of option trading

Do you know why you want to trade options? Is it the high percentage gains that are possible or is it because of the leverage that trading options can give you? Or is it because you can get started with very little money in comparison to trading stocks?

Then on top of that do you know what option strategy you want to use to make your gains? Obviously I like the conservative methods of trading credit spreads, iron condors, and diagonal spreads. How about you have you thought about what strategy you like and what fits your style?

Here’s an article for the beginner that is a must read that focuses on what I just asked you here.  Trading Options In A Modern Market 

option strategies, trading options

Bullish Option Strategies

Strategies employed in options trading can generally be classified in three categories – bullish, bearish, or neutral.

An options trading strategy is classified as bullish when the underlying stock price is expected to increase. In order to implement the most effective strategy, one must ascertain exactly how much the stock price can increase and the time frame in which the bullish move will occur.

Bullish strategies can range from one extreme to the other. The most bullish options trading strategies is a simple call buying strategy. But since stocks rarely increase by huge margins, many traders employ a moderately bullish trading strategy.

With the moderately bullish strategy, a target price is set for the run and bull spreads are used to minimize any associated risk. With moderately bullish strategies, the maximum profit is capped. Yet they still usually cost less to employ or even give you a credit. Hence my favorite option strategies are option spreads.

Here is a list of Bullish Option Strategies -

• Long Stock
• Long Call
• Short Put
• Synthetic Long Call
• Covered Call
  
• Covered Straddle
• Synthetic Long Stock
• Collar
• Bull Call Spread
• Bull Put Spread
• Call Time Spread
• Ratio Call Spread

 Of course my favorite being the Bull Put Spread.

bull put spread, bullish option strategies

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