Hello Smart Option Sellers! The stock market has really taken a positive turn in the last two days. The move up started yesterday as possible results from France's upcoming political election were becoming more clear. Obviously, the market likes Emmanuel Macron's more centrist ideas, and as it seems he has more of a chance to win, it could continue to help global markets. That news, coupled with some good earnings results being reported here in the U.S., has just given the NASDAQ its first ever move above the 6,000 point mark. That's a new all-time high. The Dow and S&P 500 are not too far behind, and will probably eclipse their all-time highs as well in the next day or two, if the momentum keeps up. What does that mean for us? Two-fold: 1. It's great for all of our current put-sell positions. Every single one of our trades are in the black. Can't be upset with that. 2. As I've lamented many times in the past, a market that moves up unabated for a majority of the time, does not give us the best conditions for finding new put-sell trades. This is why I'm always hoping for a decent pull-back now and again. When we get a pull-back, it allows the froth out of the system and brings volatility back into the market. It's that rise in volatility that helps pump up the put option prices (which we like!). Here's a few simple visuals to help you understand why volatility is so important in option trading. The first picture is a volatility chart of Verizon (VZ). It plots the one-year movement of volatility in the stock.This is not a stock chart.
The blue line measures the actual "erracticness" (historical volatility - HD) of the stock over the last year. As you can see, it definitely fluctuates, but in just the last six weeks alone, its volatility has dropped from 18% down to a low of 10%. The reason for the drop? Because the actual trading range of VZ stock (not pictured) stayed in a relatively tight range during that time. The tighter the trading range, the lower the volatility will turn out to be. The green line measures what market participants, i.e. option traders, thinks its future erracticness (implied volatility - IV) will be in the future. Obviously, the two lines don't always agree, as predictions don't necessarily pan out. You can see the many divergences on the chart. How does this affect us? When pricing out put options to sell, we can see in the next two pictures how much volatility has an affect on the values. In this hypothetical example, with VZ stock at $47 per share, I've set its October 2017 $39 options with a volatility component of 25% (circled on the left side). It gives the $39 put option a value of $.65 per contract (circled on the right).
Now, if we use real conditions and drop the volatility by 8% down to 17% (circled on the left), we see the same $39 put option now has a value of $.17 per contract (circled on the right).
So, an 8% decrease in volatility dropped the put option value by almost 74%! That's the power volatility has on the price of options, and you can see why I get irked when volatility keeps dropping. We need volatility to go up sometimes, not down, as it always seems to be doing. You can use a chart of the VIX to get a gauge of volatility for the overall market, as it's values are derived from the S&P 500 options.
The VIX has been scraping along multi-year lows for months, and just hit an intra-day low of 10.50 today, which is its lowest point since December 2006. If you're an options trader using the SPY (an ETF which tracks the S&P 500) as your investment vehicle, you no doubt have seen this drop in volatility in just the last few days. Pretty unbelievable. So. that's your lesson for today. Hoping we get any kind of meaningful pull-back as that will allow us to jump into some more new trades. For now, continue to hold all positions as-is. And speaking of new trades, earnings season is in full swing as I mentioned last week. I may have another unofficial trade for tomorrow, so stay tuned for that. Continue to send me your questions. You can always contact us here. Regards, Lee Let's Grab That Cash!