Another Way To Play The Option Volatility

Stock option volatility

Option Volatility: Got a great email from a member about how he made some quick profits from the recent volatility…

“Allen,

I had a wonderful two days with this volatility, by changing your procedure slightly.

The changes I implemented are:

1. When it looks like we are in a bearish market, do only the bearish call spread and NOT the bullish put spread. Do the converse when in a bullish market.

2. In a volailte market that whipsaws, do not close out both the high and low strikes simultaneously. Rather close out the short position first, since that is the one costing us the maintenance requirement. The long position has no impact on the maintenace margin requirement.

This is what happened:

On Thursday May 06, being my birthday, I wanted to try my luck at Day Trading with options, since the market looked quite volatile!

Did a RUT May 720/730 bearish call spread. Bought the 730 call at 2.39 and sold the 720 call at 3.99 for a $1.60 credit.

At about 2:30 I tried to buy the 720 call back to close. The screen went bonkers with ask prices lower than bid prices! Then all I got was the dreaded hour glass image!! This is when the market went crazy!!

Around 3:45 EDT, I gave up and entered a buy order good till cancelled for the the 720 call at a price of $2.00 and then went away from the computer.

Around 4:30 to my surprise, I found this was executed at 4:03pm, for a profit of 1.99 !!

Today, Friday after hearing the super jobs report, I entered an order to sell the 730 Call at $2.00 each. It had was bid at < 50 cents depending on where you looked!!  To my shock, this order got executed by 11:00 am EDT!!  It closed at 1.15 today! My loss 0.39. So the net profit was (1.99-0.39) or 1.60. Or I got to keep 100% of the credit received without waiting for expiration!

On a 100 contract spread, with the commission included, the profit was $15,679 or 18.6% in two days!!

While I do not quite follow your exact steps you suggest, I would not have had the guts to do this without reading your material.

Thank you”

I am posting this email for educational purposes only. I am glad this member did well but it could just as easily turned out badly. I agree with his strategy #1, where you only sell options on the side that is away from where the market is going. But I am not smart enough to always be able to tell which way the market is going. If I was, I would just buy puts or calls and ride them.

Option Volatility

Ever since March 2009, the market has pretty much gone straight up. But every day there is someone somewhere saying there will be a correction and the market will come back down. I myself expected the market to go up until after 1st quarter earnings. But the rally sustained until 2nd quarter earnings.

Now with the increase in volatility and fears of Eupore the markets seems to be taking a breather before they pick the direction. It might be back up, it might be down, or it might be flat.  To me it doesn’t matter as long as the move happens slowly.  An option seller can make a ton of money when the market moves less than 1% each day.

As for strategy #2, this is a bit more risky because if you buy back the short option and the market rebounds you can lose money very quickly. But this is an adjustment I have read about so there are traders who use it. Never used it myself though.

2 Comments

  1. Raj Iyer on May 19, 2010 at 10:24 pm

    Allen,

    Thank you for the compliments. I think I had a dose of beginner’s luck with iron condors.

    I want to thank you for the lesson that one does not know market direction for a whole day, let alone a whole month. So, you are absolutely right about the risk of taking only half (the bullish or bearish) the position and not both spreads.

  2. Xueren Zhang on May 25, 2010 at 11:52 pm

    It definitely makes sense to sell call spreads in a bear market and do the put spreads in a bull market.But,I am not sure about your second point.

    This year , Allen’s ideas of iron condors have not been going smoothly,because the market has been going up and down too fast.But I have figured out that if we trade the spreads with higher probalities,let’s say 85% to 90% ( instead of 70% he has designed),then most of trades didn’t need adjustments ( Spx may 1080-1070 and Mnx 190-185 even suffered a max loss!).Then,so-called ROI would be a lot lower,but we would have a better sleep.
    I am not sure if Allen understands my point,but his ideas only work well in a calmer market,up and down less than 5% in a month.
    Actually,it’s better to avoid the market in current condition,and don’t trade until we have an absolute opportunity,especially for our beginners.

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