I'm trying to wrap my head around what the IV smile means for a stock and I have some ideas, but wanted to make sure they aren't misguided. In my case, I am considering buying SPY LEAPS (e.g. 2 years), and noticed that the bottom of the IV curve is also approximately where I expect the shares to be. For near month and weekly options the low point is almost always ATM, and the sides of the curve are very steep. However, for longer options the low point is usually very deeply OTM, and the curve is much flatter. My interpretation of this is what I want feedback, so I am looking for input on the following statements:
- For buy-and-hold strategies, it's generally better to buy at low IV, and sell at high IV. This means it's better to buy OTM now, and sell ~ATM later. The alternative strategy, buying ATM now, and selling ITM later, all else being equal, is worse because the strikes would be much farther up the curve.
- The low point in the smile is where, on average, people think the price is going to be. The reason the low is ATM for near options, and OTM for SPY, is based on the expectations of where SPY will be in a few years.
- If the previous idea is true, this also means it's reasonable to derive where the stock price should be in 2 years. This should hold for any security that is optionable. A side example is that for something like SQQQ, which suffers from volatility drag, will not achieve the -3x of the long term. However, using the volatility smile, we can see the bottom of the curve is around ~2x which would account for the drag.
- The IV curve being steeper OTM/ITM for near options is due to the higher level of certainty about where the price will go. A trader with an advantage over the market can charge more or offer less, since they know more where the price will actually go. The LEAPS curve is much flatter because much less is known about the future. There is less of an advantage to be had. (I use this to hopefully justify that I am not getting ripped off
)
I don't have a picture handy, but there are some 3D graphs of the IV with money-ness, expiration, and IV. It appears like a canyon. My mental model is if I put ball at the starting point, the ball would roll towards the lowest point, wobbling back and forth along the way. I'm curious how other people think about IV, and if my ideas above have any merit?
- For buy-and-hold strategies, it's generally better to buy at low IV, and sell at high IV. This means it's better to buy OTM now, and sell ~ATM later. The alternative strategy, buying ATM now, and selling ITM later, all else being equal, is worse because the strikes would be much farther up the curve.
- The low point in the smile is where, on average, people think the price is going to be. The reason the low is ATM for near options, and OTM for SPY, is based on the expectations of where SPY will be in a few years.
- If the previous idea is true, this also means it's reasonable to derive where the stock price should be in 2 years. This should hold for any security that is optionable. A side example is that for something like SQQQ, which suffers from volatility drag, will not achieve the -3x of the long term. However, using the volatility smile, we can see the bottom of the curve is around ~2x which would account for the drag.
- The IV curve being steeper OTM/ITM for near options is due to the higher level of certainty about where the price will go. A trader with an advantage over the market can charge more or offer less, since they know more where the price will actually go. The LEAPS curve is much flatter because much less is known about the future. There is less of an advantage to be had. (I use this to hopefully justify that I am not getting ripped off
)I don't have a picture handy, but there are some 3D graphs of the IV with money-ness, expiration, and IV. It appears like a canyon. My mental model is if I put ball at the starting point, the ball would roll towards the lowest point, wobbling back and forth along the way. I'm curious how other people think about IV, and if my ideas above have any merit?
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