Advanced Time Spread Trading: Using Volatility Skew for Edge

Transcription

1 Advanced Time Spread Trading: Using Volatility Skew for Edge Dan Passarelli Market Taker Mentoring, Inc. MarketTaker.com Twitter.com/Dan_Passarelli

2 Disclaimer In order to simplify the computations, commissions and other costs have not been included in the examples used in this presentation. These costs will impact the outcome of stock and options transactions and should be considered. Investors considering options should consult their tax advisor as to how taxes may affect the outcome of contemplated options transactions. Options involve risks and are not suitable for all investors. Prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options (ODD). Copies of the ODD are available from your broker, by calling OPTIONS, or from The Options Clearing Corp., One North Wacker Drive, Suite 500, Chicago, Illinois The information in this presentation is provided solely for general education and information purposes and therefore should not be considered complete, precise or current. No statement should be construed as a recommendation to buy or sell a security or to provide investment advice. Copyright 2016 Market Taker Mentoring, Inc. All rights reserved.

3 Time Spread Review Buy a call (put), sell another call (put) on the same underlying, with the same strike, but a shorter expiration

4 Volatility and Skew

5 Volatility Refresher / Crash Course Realized Volatility Lay definition: How much the stock has moved around lately Textbook definition: The annualized standard deviation of an asset price Synonym: Historical volatility Implied Volatility Lay definition: How cheap or expensive options are Textbook definition: The volatility figure that when entered in an option-pricing model yields a theoretical value reflecting current market prices Interpreted as the market s estimation of future volatility in an asset The volatility implied by option prices

6 Skew The observation that options on the same underlying may have different implied volatilities Vertical skew (strikes) Term structure of volatility (expirations)

7 Vertical Skew Successively lower strikes tend to have higher vol Courtesy of Fidelity Prices not current Image is for illustrative purposes only.

8 Professional Vertical Skew Trading Technique Model the slope of the skew Buy or sell vertical spreads when slope deviates from norm Normal Vol Skew Strike Vol Downside Skew Strike Vol Sell 75s Buy 79s

9 Term Structure of Volatility Successive expirations can have higher or lower vol Courtesy of Fidelity Prices not current Image is for illustrative purposes only.

10 Professional Term Structure of Volatility Trading Technique Compare vol of different expirations Look for volatility events, rationale for vol disparities By or sell time spreads Expiry Vol May 34.6 Jun 29.1 Jul 28.4 Oct 28.0 Sell May Buy Jul

11 Professional Trading Objective on skew trades: Make a couple volatility points Profit = vol move X vega X contracts Must trade BIG size How can non-professional traders benefit from skew?

12 Skew for the Rest of Us Skew is extremely important in your trading If you spread, you are trading skew; strive to profit from it

13 Improving Your Time Spread Results Time spread results are improved by using term structure of volatility to your advantage Use vol as a screen for time spread candidates

14 Volatility Screening Courtesy of Fidelity Prices not current Image is for illustrative purposes only.

15 Why Volatility Skew Matters Prices not current With skew, can buy spread at 0.45 If there was no skew (if May vol was 30 [about 4 points lower]) May calls would be 1.30 bid (4 vol points x 0.05 vega) Thus, spread would cost 0.65 Greater cost means: Bigger max loss potential Smaller max gain potential Tighter break evens (lower probability of success) Worse trade Can make profit in short-term if vols converge

16 Other Considerations Need range bound stocks (gamma risk) Avoid earnings and other volatility events* If vol is high *Possible to trade earnings using time spreads, but more to consider

17 Skew Guidelines and Potential Misguidance Vertical spreads Skew, vegas and bid-ask width

18 FREE ebook 6 Ways to Generate Income Using Options MarketTaker.com/Fidelity

19 This has been a presentation of Market Taker Mentoring, Inc. MarketTaker.com Dan Passarelli Dan@MarketTaker.com Twitter.com/Dan_Passarelli (815)