Account Destruction.

[Maverickz]

Quote from ForexForex:

That's what got him into trouble in the first place, he was selling premium when volatility was very high. Sell high, buy higher.

3 month chart of the overall market

Not a good time to be a seller of options.

It wasn't the selling of premium that was his problem it was the deltas. There are a lot of spread plays for different market conditions. When volatility is high, you can use Bull Put Credit spreads or Bear Call Credit spreads depending on market direction. A directional Strangle might even be good with exceptionally high Volatility. When volatility is low you use debit spreads. When volatility is around the average then ratios, calendars, and maybe even butterflies or IC's can be good.

As mentioned selling premium right now is better, you just have to make sure you are right on direction too. Unfortunately the advice he was given was to buy (naked) puts. Buying premium at crazy high volatility levels with no hedge in place at all is just stupid IMHO. If you really think the market is going to keep dropping and really want to use naked options then I would sell calls vs. buying puts right now. That way if the market goes up and volatility drops you will lose LESS money since the decreasing volatility will help you while the price action goes against you. The advice as given would cause both to work against you simultaneously and do severe damage to your account....very fast.

 

[ForexForex]

Quote from Teycir:

@ForexForex; it may sound counter intuitive, but high volatility provide more security to call writers.
The reason is when IV is up that means that the trend is downwards (VIX very rarely goes up on bull market) and that you can write further otm calls due to inflated option premiums, so this decreases the chances of being ATM on expiration, also the high vola increases the frequency of overbought signals in comparison to a flat market, so you can get in and out more frequently reducing exposure to the market.
But we must be aware that the call spread is not always the best choice in bear market, some times just buying puts is more rewarding if the bid/ask gap is too wide incurring double slippage if you choose spreads. I noticed some times some mispricings on options favoring puts over calls.
It is important to be flexible.
I use optionsVue, and choose my trade bases on expected return/worst case return ratio, if the long put has better ratio than the call credit spread, then I choose the long put, if not I prefer the credit spread for its Theta, stability and flexibility (buy back the loosing short leg and let the long leg run, switch to condor...).

Quote from Maverickz:

It wasn't the selling of premium that was his problem it was the deltas. There are a lot of spread plays for different market conditions. When volatility is high, you can use Bull Put Credit spreads or Bear Call Credit spreads depending on market direction. A directional Strangle might even be good with exceptionally high Volatility. When volatility is low you use debit spreads. When volatility is around the average then ratios, calendars, and maybe even butterflies or IC's can be good.

As mentioned selling premium right now is better, you just have to make sure you are right on direction too. Unfortunately the advice he was given was to buy (naked) puts. Buying premium at crazy high volatility levels with no hedge in place at all is just stupid IMHO. If you really think the market is going to keep dropping and really want to use naked options then I would sell calls vs. buying puts right now. That way if the market goes up and volatility drops you will lose LESS money since the decreasing volatility will help you while the price action goes against you. The advice as given would cause both to work against you simultaneously and do severe damage to your account....very fast.

LOL Try explaining that load of BS to PurpleOne.

 

[Maverickz]

Quote from ForexForex:

LOL Try explaining that load of BS to PurpleOne.

It's not BS, but I am not going to teach it either. If he doesn't understand the Greeks and how they affect trades then he shouldn't be trading options.

 

[Teycir]

@MaverickZ; don't answer to trollers who know nothing about options so this thread stays clean.

 

[Maverickz]

Actually I will try help explain Volatility a little bit. In an effort to make this as platform independent as possible I made a chart using OpenOffice Calc with numbers I got from ivolatility.com. I actually have this charted out in my platform but I threw this chart together to show how anyone can use this.

First off if you are trading options and are not using a platform that will give you volatility numbers then you should at least get a free account from www.ivolatility.com. The free account is based on YESTERDAY'S Close but it is much better than trading blind.

Looking at the chart below the Blue line is the 52wk high Implied Volatility (IV) of the SPY, the Red line is the 52wk low, the yellow line is the AVERAGE of the high and low and the green line is the CURRENT IV.

The first thing to know about volatility is that higher volatility means there is more premium in the options prices and less volatility means less premium in the options price. The second thing to know is that Volatility is very prone to "mean revision", meaning that it has a strong tendency to revert closer to the average levels.

Taking this into consideration, the closer the Current IV is to the 52wk high the more negative vega (short volatility) you want to have. As the current IV moves closer to the average you want Vega to become more and more neutral with almost 0 Vega at the average. Then as it moves toward the 52 wk low you start wanting more and more positive Vega (long volatility).

The two key deciding factors in which options play to use should be market direction AND volatility as mentioned above. Failure to pay attention to BOTH of these will decimate your account.

 

[hlpsg]

When vols are high and there's been a big drop, there's also a very high probability of there being a big and fast jump up in prices if the news or condition that caused the dip is reversed. We have a few very good examples just looking at any of the US stock indices in the past 2-3 years.

So I don't agree that high vol provides more security to call writers. When vols are high, the price could move very fast either way, depending on how the situation plays out.

Quote from Teycir:

@ForexForex; it may sound counter intuitive, but high volatility provide more security to call writers.
The reason is when IV is up that means that the trend is downwards (VIX very rarely goes up on bull market) and that you can write further otm calls due to inflated option premiums, so this decreases the chances of being ATM on expiration

 

[Teycir]

A good way to judge the price of the option is to use IV/SV ratio and confirm with the options volume. Simple IV 52 week high/ low, is a good start buth not enough, because in some markets, like this one the volatility stays high for long time.
Look at the SPY chart I posted. The point A is more interesting than the point B for an option seller because the IV/SV ratio is higher, even at both point IV is around 41%.

 

[Teycir]

Quote from hlpsg:

When vols are high and there's been a big drop, there's also a very high probability of there being a big and fast jump up in prices if the news or condition that caused the dip is reversed. We have a few very good examples just looking at any of the US stock indices in the past 2-3 years.

So I don't agree that high vol provides more security to call writers. When vols are high, the price could move very fast either way, depending on how the situation plays out.

Assume the price goes up very quickly on the index, which is not as frequent as the reverse (sudden price plunge).
In this case the IV decreases thus deflating option price so I'm not hurt badly.
In the reverse situation which is way more frequent (sudden drop in the index), the IV surges and I can get killed.
[look at the SPX chart attached].

 

[Teycir]

Quote from Teycir:

Assume the price goes up very quickly on the index, which is not as frequent as the reverse (sudden price plunge).
In this case the IV decreases thus deflating option price so I'm not hurt badly.
In the reverse situation which is way more frequent (sudden drop in the index), the IV surges and I can get killed.
[look at the SPX chart attached].

Here the SPY chart since inception. The downside trend is steeper than the upside trend, you can look at other charts, you'll see that more often than not this pattern repeats itself.

 

[Maverickz]

Quote from hlpsg:

When vols are high and there's been a big drop, there's also a very high probability of there being a big and fast jump up in prices if the news or condition that caused the dip is reversed. We have a few very good examples just looking at any of the US stock indices in the past 2-3 years.

So I don't agree that high vol provides more security to call writers. When vols are high, the price could move very fast either way, depending on how the situation plays out.

You don't have to just sell naked calls to be selling premium. You can sell naked puts, use a Bear Call Credit Spread, use a Bull Put Credit Spread, Short Directional Strangles, etc. All of those plays give you a varying degree of NEGATIVE VEGA exposure (short volatility). Many also give you a hedge while still allowing you to play a bull or bear market in high volatility environments without needless Vega risk. When Volatility is abnormally high, which is more likely: it keeps rising or it returns to the mean?