As a quick topic, I'd like to hear everyone's thoughts regarding IV and how it affects a vertical spread. Also whether high/low IV would encourage/discourage one from selling/buying a vertical spread.
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Vertical Spreads for Aggressive Growth
- Thread starter Cache Landing
- Start date
The vertical spread's greeks depend on its legs' strikes and time to expiration. The best way to see how IV affects it is to draw the position's price-time graph for two IV values, i.e. 20% higher and 20% lower than current. Compared to a straight option a vertical spread will have less vega, theta and risk exposure, but will limit the potential profit, increase the slippage and commissions too. In general, when IV is in a historical high percentile it's better to open the short leg at- or near-the-money; when IV is in a low historical percentile it's better to open the long leg at- or near-the-money. Following the same idea: when IV is high a vertical makes more sense than when IV is low.
To estimate if the IV is high or low, it should be compared to its historical values in relation to major events such as earnings. In most cases IV is not related to the underlying's historical volatility. Also, betting on IV's mean reversal is many times a losing approach, as IV can stay in extreme percentiles for long time; see the low IV environment of the past few years.
To estimate if the IV is high or low, it should be compared to its historical values in relation to major events such as earnings. In most cases IV is not related to the underlying's historical volatility. Also, betting on IV's mean reversal is many times a losing approach, as IV can stay in extreme percentiles for long time; see the low IV environment of the past few years.
Quote from Cache Landing:
As a quick topic, I'd like to hear everyone's thoughts regarding IV and how it affects a vertical spread. Also whether high/low IV would encourage/discourage one from selling/buying a vertical spread.
Not sure there's much to add without stating the obvious.
My take on it:
If you're a trader that trades based on expiration risk profiles, IV fluctuations and activity in the interim is virtually irrelevant for you. It has no bearing on the expiration result - you either win or you lose.
If however, you're a trader that pays more attention to running P/L and perhaps tries to take advantage of that or trade around it, then having some sort of IV forecast is helpful.
If you believe in mean reversion tendencies for IV then the simplistic approach is to sell IV when it is high and buy IV when it is low etc. There is however, no way of knowing if IV will continue to rise if it is high and vice versa. [EDIT]As pointed out by cnms2 above[/EDIT]
How this applies to verticals is defined by the vega charactersistics of the vertical. For example, an OTM credit spread/ITM debit spread has short vega i.e. these verticals want IV to decrease to make money. Therefore, it might be suggested by some to use these short vega spreads on underlyings where you feel IV is forecasted to fall. The spread obviously also has to match your delta preferences. The reverse is true for ITM credit spreads/OTM debit spreads - they are long vega. They want IV to increase
Furthermore, the magnitude of vega is determined by how far OTM/ITM the vertical is. If you have a FOTM credit spread for example, gamma is your main exposure and vega or IV activity is of less concern.
Lastly, the time to expiration for the vertical also effects the magnitude of vega for the position. Generally, the further away, the larger the importance if IV activity.
MoMoney.
My take on it:
If you're a trader that trades based on expiration risk profiles, IV fluctuations and activity in the interim is virtually irrelevant for you. It has no bearing on the expiration result - you either win or you lose.
If however, you're a trader that pays more attention to running P/L and perhaps tries to take advantage of that or trade around it, then having some sort of IV forecast is helpful.
If you believe in mean reversion tendencies for IV then the simplistic approach is to sell IV when it is high and buy IV when it is low etc. There is however, no way of knowing if IV will continue to rise if it is high and vice versa. [EDIT]As pointed out by cnms2 above[/EDIT]
How this applies to verticals is defined by the vega charactersistics of the vertical. For example, an OTM credit spread/ITM debit spread has short vega i.e. these verticals want IV to decrease to make money. Therefore, it might be suggested by some to use these short vega spreads on underlyings where you feel IV is forecasted to fall. The spread obviously also has to match your delta preferences. The reverse is true for ITM credit spreads/OTM debit spreads - they are long vega. They want IV to increase
Furthermore, the magnitude of vega is determined by how far OTM/ITM the vertical is. If you have a FOTM credit spread for example, gamma is your main exposure and vega or IV activity is of less concern.
Lastly, the time to expiration for the vertical also effects the magnitude of vega for the position. Generally, the further away, the larger the importance if IV activity.
MoMoney.
Quote from Cache Landing:
As a quick topic, I'd like to hear everyone's thoughts regarding IV and how it affects a vertical spread. Also whether high/low IV would encourage/discourage one from selling/buying a vertical spread.
Decided to finish off an IC on GS by selling a bear call.
Today's Action
Sell 1 GS MAR 150/155 call spread @ 1.00
Year to Date P/L
Account Value: $10,033.00
YTD Gross P/L: 90.00
YTD Commiss: 57.00
YTD Net P/L: 33.00
YTD % P/L: 0.3%
Today's Action
Sell 1 GS MAR 150/155 call spread @ 1.00
Year to Date P/L
Account Value: $10,033.00
YTD Gross P/L: 90.00
YTD Commiss: 57.00
YTD Net P/L: 33.00
YTD % P/L: 0.3%
I see what you mean with your GS bear call: a retracement toward 140 before the March expiration seems likely (a bearish divergence is forming too). What is the other wing of your IC? Are you looking to hold your IC longer (forecasting a GS range bound) or you're trying to squeeze a little more from the bull vertical?
Quote from Cache Landing:
Decided to finish off an IC on GS by selling a bear call.
Today's Action
Sell 1 GS MAR 150/155 call spread @ 1.00
Year to Date P/L
Account Value: $10,033.00
YTD Gross P/L: 90.00
YTD Commiss: 57.00
YTD Net P/L: 33.00
YTD % P/L: 0.3%
Quote from cnms2:
I see what you mean with your GS bear call: a retracement toward 140 before the March expiration seems likely (a bearish divergence is forming too). What is the other wing of your IC? Are you looking to hold your IC longer (forecasting a GS range bound) or you're trying to squeeze a little more from the bull vertical?
The other wing was a 130/135 bull put @ 1.00
I realize that they are in "blue sky territory" but I think a retracement is very likely. I still have an overall bullish opinion on them though. If all goes as planned I will stay in the original bull put until expiration (or until I can buy it back for .05). I finished off the IC because I expect a retracement and it cost me nothing in terms of BP. Trying to capitalize on a retracement, thereby adding a little more cushion to the bull put. Unless GS suddenly becomes rangebound, I plan on exiting the call wing early.
Decided to finish off the RIMM IC.
SOLD 1 85/90 bear call @ 0.60
SOLD 1 85/90 bear call @ 0.60
Sorry I didn't have time to update in real time today. I tried to sneek in a little note when I sold the RIMM vertical. Actually, when PALM hit $40.00 (recent resistance), I set a trailstop. I was stopped out at $5.70 when it started to correct at the end of the day. I think it still has something left in it, but I'm not going to complain about a profit. Anyway, here's the latest.
Today's Action
SOLD 1 RIMM MAR 85/90 bear call @ .60
SOLD 1 PALM MAR 35call @ 5.70 for a 68% return.
Year to Date P/L
Account Value: $10,258.50
YTD Gross P/L: 320.00
YTD Commiss: 61.50
YTD Net P/L: 258.50
YTD % P/L: 2.6%
Today's Action
SOLD 1 RIMM MAR 85/90 bear call @ .60
SOLD 1 PALM MAR 35call @ 5.70 for a 68% return.
Year to Date P/L
Account Value: $10,258.50
YTD Gross P/L: 320.00
YTD Commiss: 61.50
YTD Net P/L: 258.50
YTD % P/L: 2.6%
Just a reminder. Some might be wondering about the RIMM IC. Technically speaking it increases the account value because of the credit recieved without tying up more margin. I am not including the credit on these in the account value until it is realized in the end. As it was beautifully put earlier in this thread, it is merely a loan until the trade works out in my favor.
My opinion on RIMM is that I don't think it will get above 85 or below 60. I'm planning to stay in this IC until expiration (for a return of 56%). By finishing off the IC on both RIMM and GS and then selling the PALM call, I am really bearish right now. I don't like this, so I'll be looking hard for some bullish plays this weekend. Any contributions would be appreciated.
My opinion on RIMM is that I don't think it will get above 85 or below 60. I'm planning to stay in this IC until expiration (for a return of 56%). By finishing off the IC on both RIMM and GS and then selling the PALM call, I am really bearish right now. I don't like this, so I'll be looking hard for some bullish plays this weekend. Any contributions would be appreciated.