Basic Questions on IV

[ironchef]

Welcome. My lessons learned after three and a half years:

1. Some of the best/smartest traders trade options, including all the experts at ET.
2. My counter parties were not there to hand me free money, most likely they knew something I did not.
3. The market is quite efficient, any simple technique will likely not be profitable in the long run with the law of average applied.
4. There are ways to profit but they are not obvious to the casual traders.

Simple case in point, I very quickly noticed when the underling dropped, IV went up to compensate, same when the underlying went up, IV went down. If that was not the case, I needed to fully understand why before I traded or I would be the one handing free money to my counter parties.

Good luck.

 

[Jones75]

I've recently started to dabble in stock options after having quite a bit of success with trading stocks successfully. Essentially I am attracted by the idea of unlimited profit potential with limited risk. I would prefer just to buy calls and puts if possible.

So far I have had mixed success. I've done the research and I've found IV to be the culprit of my losses despite the underlying increasing (in the case of calls).

My understanding is that the price of the underlying and change in IV have the biggest effect on stock option prices. Therefore to succeed I would need the underlying to go up and the IV to go up as well. This would imply that I would need to buy options that have a low relative IV.

However the confusion that comes about is that fact that each strike price has it's own IV resulting in what seems to be called the Volatility Skew.

So if I have understood things correctly I should check the IV of that particular strike to the IV of the strike 20 to 30 days ago to see whether the current IV is relatively high or low. Have I understood this correctly?

Also somewhere I ready that if I buy an option of a stock that is at a market bottom and that starts to go up then the IV will most likely go down. How strong is this correlation? Am I doomed to using options to leverage my mean reversion strategy?

You sound like the way I started out. After spending about 7 years as a value investor, the lure of options appeared. I played long ITM options as replacement, and for about 2.5 years did great. Then came the oil crash, and I gave most of what I made back.

After trying various strategies, today, I use long put synthetic straddles as my core. I feel a lot better owning the stock, and backing it up with puts. Ivol is all relative. Since I don't like staying in a position too long, stat vol is more important to me. I need the underlying to move up or down, not stagnate. Svol and beta are usually a good tell tale.

The following has cost me more money than anything else:
Wide b/a spread (liquidity problems)
Staying in too long (time) when the strategy was to be out in x number of days. (theta bites)

good luck!

 

[CBC]

Hi BFC,

I know how you feel regarding IV, market moving in your favor and the options barely moving X(.

I got so angry sometimes that I wanted to hold the option to expiry and hopefully get a nice run then make the MM squeal like a stuk pig.

The only way to trade was to buy puts in my opinion. As the market moves in their favor IV rises.

 

[optionshedge]

You can try to reduce the impact of IV when trading directionally if you use vertical spreads, instead of buying outright calls / puts. For instance, if you are bullish, you can buy call vertical spreads instead of outright calls to reduce the impact of IV moving against yet.

 

[CBC]

Yea I'v had a few people advise me to trade spreads. From what I understand they aren't very profitable tho.