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Volatility Indexes: VIX and RUT

Interesting story in today’s Wall Street Journal online.

Most people are familiar with the VIX, the CBOE Volatility Index. It uses options prices to measure the expected volatility of the S&P 500 index. A lesser known index is the RVX, the CBOE Russell 2000 Volatility Index. This uses the exact same formula as the VIX, but applies it to the Russell 2000′s stocks.

As you might imagine, the RVX has historically run higher than the VIX, given that it measures the expected volatility of an inherently more volatile small-cap stock index. According to Russell Investments, the “premium,” or the difference between the two indexes, has historically been around 29%. But in 2014, a year that was at first a wild ride for small-caps, and then a wild ride for everyone, the relationship between the two has been both historically wide, and historically narrow.

Read the whole story at the WSJ site

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Iron Condors and Soaring Option Volume

(Reuters) – Growing concerns about the economy and markets sent volatility soaring on Wednesday [Oct 15, 2014] and pushed trading volume in the U.S. options market to its highest level in more than three years, as traders moved to hedge their portfolios on fear of further market gyrations.

You can read the whole article at the Reuters site.

Is it time for Iron Condors?

The increase in implied volatility suggests that investor complacency may have ended and that fear has returned.

The question for traders is whether it is time to adopt premium-selling strategies (the iron condor, for example), or if it is better to wait for even higher volatility. One thing is certain: getting into this game before the volatility highs have been reached is a treacherous undertaking. I recommend waiting because it is better to avoid iron-condor risk when we do not know whether the current period of increased volatility is just beginning.

My advice: If you are an experienced iron condor trader, it is okay to nibble, but I would not want more than 20% of my cash (the cash set aside for strategies such as the iron condor) in play at this time.

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Volatility and News

Although I am a believer in using options to hedge positions and reduce list, there is no doubt that there are many speculators who use options.

The purpose of today’s post is to warn those speculators about a dangerous trap — one that can be avoided.

News Pending

When a news release is pending, option volume increases because the news may result in a gap opening for the stock price (when the news is better or worse than expected). That is when option buyers make good money — assuming that they got the direction right.

However, there is much more to trading options under these circumstances than the novice trader can anticipate. That option volume pushes prices higher and you cannot pay whatever price is asked when buying options. At least you cannot do that and expect to succeed.

Read more about this scenario at my site.

The discussion continues with a description of how implied volatility is crushed once the news is released. If you are not familiar with the concept that the price of options in the market place is very dependent on implied volatility, take a look here and here.

One method for significantly reducing the cost of playing this game is to trade call or put spreads instead of buying individual options.

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I published a new blog post about volatility at

Although the article is short, it contains links to a bunch of other (brand-new) articles on various aspects of volatility, with most of the information geared to newer option traders.

What is Volatility?

Volatility Products for Trading.

Option Volatility and Black Monday.

Volatility and Option Premium.

An Options Pricing Model.

Volatility: A Topic for New Traders?

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Special Webinar: Trading VIX and related ETNs.

It is my pleasure to invite each reader to an important webinar.

    Wednesday, April 17, 6:00 PM CT. Register

The good news is that attendance is free for this 50-minute Webinar.

The better news is that the speaker is Mark Sebastian, COO of Option Pit. Options education is a serious business and it is important to learn how the options world works from serious educators. I believe Mark deserves membership in that class of teachers.

The best news is that the topic is something of interest for all option traders — using VIX and other volatility products.

    Trading VIX and VIX ETN’s

The relationship between VIX, VIX futures & the VIX ETNs


April 17, 2013. 6:00 PM CT

One of the more difficult concepts to grasp in the options universe is the relationship between VIX (CBOE Volatility Index), VIX futures, and VIX ETN’s (Exchange Traded Notes*). Many traders make costly errors regarding VIX options. Learn to avoid these simple mistakes.

Mark Sebastian discusses the interrelationship of VIX, VIX futures, and VIX ETN’s. Included: the pitfalls of the ETN’s. He will also cover ways to take advantage of trading VIX based options.

    *If you do not know what an ETN is, here is one definition: A type of unsecured, unsubordinated debt security that was first issued by Barclays Bank. This debt security differs from other types of bonds and notes because ETN returns are based upon the performance of a market index minus applicable fees. There are no periodic dividend or interest payments; principal is not guaranteed.

Take advantage on an opportunity to further your options education.

This webinar, presented by the 2Marks, is my way of thanking you for showing interest in Options for Rookies and this blog.

You do not have to invest in ETNs to benefit from understanding their role in the options universe.

See you at the webinar!

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The Stretched Collar, Again

Thanks Mark for your prompt reply. After reading two of your books and this blog, I must say that options trading is becoming less scary and more appealing to me, so thank you.

Amir, “Less scary” is very good. But please do not become overconfident.

I’ll explain my logic regarding my second question – buying longer term put option (6 month for example) and selling monthly call option against it in a collar strategy.

I trade index futures, Emini S&P (symbol: ES) and Emini Nasdaq (NQ). The CME provides margin discounts for Inter Commodity Spreads

I believe that the Nasdaq will outperform S&P – so I’m long 2 NQ and short 1 ES (that’s my “portfolio”). Now lets add the options to the soup as follows:
Sell 2 OTM CALL (NQ)
Buy 1 OTM PUT (NQ)

The credit from selling 2 calls will cover the cost of the put.

I need a bit of clarification. I assume you mean that after selling the calls every month for for six months, you will collect more than the cost of the put. Or, are you telling me that you will collect that much the first month?

Does the basic risk as you explained (the very expensive put loses so much money, that it kills my whole play) apply to this situation too?

If the market drops, 1 Emini Nasdaq contract is protected by the put option and the second Nasdaq contract is hedged via the short Emini S&P contract (value of 1 point NQ is $20; value of 1 point ES is $50).

What do you think? can it work?

Thanks again



Hello Amir,

When replying to reader questions, I don’t know anything about the trader. Sometimes I receive very sophisticated questions from someone who doesn’t understand what he is asking. At other times, I must be careful not to provide a rookie answer to a more sophisticated trader. It makes it difficult.

How long have you been trading? Have you been using options for a few years, or are you in the very early stages of learning? I ask because you are not using an ordinary strategy.

This question is difficult to answer. Many factors are in play. If you are a rookie, I would tell you that this is too complex and that you should get your experience with a simpler approach. On the other hand, if you are an experienced trader with experience trading this setup, then I’d be encouraging you to continue.


Almost anything ‘can’ work

The question is whether this (or any other) play has an appealing (to you) risk/reward profile.

I’ll offer comments. Use anything that’s appropriate and discard any ideas that don’t apply to you.

This position feels delta short and would not do well in a rally. The collar trade that you appear to be emulating performs much better (than this trade) when the market rallies.

1) I assume you understand the vega risk of this position. You own lots of vega from that long-term put. If the market rallies you would be in trouble. Let’s look more closely.

a) This position is naked short 1 ES contract. Yes, it appears that you own 2 NQ minis, but by writing covered calls, the upside is limited. There is nothing worse than being naked short calls (or stock or futures) in a big rally.

b) You are short 2 NQ ITM puts (equivalent to the two covered calls). Those will make good money on the upside, but the profit potential is limited. It is not enough to offset the naked ES short – on a big up move.

c) Owning an OTM, longer-term put would not only lose money on that rally, but the likely IV crush translates into an even larger loss. True you sold two shorter term options (you may look at them as either the covered call, or the naked put) – but that single, long-term put option has more vega that these two options combined. That is not good on the upside (and it’s not so good on the downside either)

The upside is risky

I understand that the delta of this position depends on which specific options that you traded, but this feels short. If it is neutral, it would become short quickly due to negative gamma.

2) What I do not like about that play is that you do not know where the market will be when it’s time to sell the next round of calls. I know that it should not matter because once expiration has passed, wherever the market is as that time, you are long 2 NQ and short 1 ES and that you can afford to write to call options. But that put option makes a big difference.

What if the market moved higher, that put is now farther OTM and offers less protection. In fact, it may soon become nothing more than disaster insurance.

That’s not a realistic collar – because the put is supposed to provide good protection because it is not far OTM. In your trade, that long put is a play on volatility. You are depending on a big IV increase to protect the value of the portfolio. Most collar buyers rely on gamma – or the fact that their long options gain delta very quickly when they move ITM.

It’s acceptable to trade vega for gamma, but it is far from riskless. I get the fact that theta is on your side and everyone loves positive theta. however, its buddy, negative gamma is where the risk lies. This position requires careful handling and adjusting if the market continues to move higher.

How far OTM is too far OTM for you? At some point you may be forced to roll that put to a higher strike? When would you make this trade? How much cash are you willing to invest? Whatever you decide, write that sum into your trade plan so you can remember to do it when the time comes.

It’s difficult to gauge such costs when you would must estimate a market level and an IV level to estimate the cost.

3) Yes: In this play the 6-month put loss could make this whole play a loser. As already mentioned, you have upside risk outside that put.

Use ‘what if’ software to examine the value of the portfolio at different prices, IV, and dates. There is no need to make this into a guessing game. You can gauge risk/reward and see where your risk lies much better if you take a look at some possibilities.

4) The downside appears to be better.

a) 2 NQ vs 1 ES ought to be a reasonable hedge – when we look at the $20 per point vs. $50 per point comparison. If NQ does not decline by more than 50% as much as ES, you are in good shape. Please remember that NQ is far more volatile than ES, and I don’t know whether 2:1 is the right, market neutral hedge. If you get the hedge right, then you will prosper if NQ outperforms.

b) You own a naked put option. That’s good in a decline.

c) You are long vega and that should be good, but not always. When IV explodes during a violent market, it’s the near-term options that explode the most. In other words, the big IV increase provides a good bonus for the price of your long put, but it’s possible – depending on time to expiration and just how much the IV jump in the front-month options exceeds that of the longer-term option – that you can lose money from the IV surge.

I recognize that you are short front month calls, and not puts, but they may not decrease in value (as the market falls) by enough to do contribute to the portfolio value. Against that naked put, you own 2 NQ vs being short 1 ES, and this is a bearish play.

One more point. This is a convoluted trade and I may not be correct in my analysis. If you want a collar, I think you should trade a collar equivalent (sell a put spread).

I am not comfortable enough with my analysis to give you advice. It just feels to be a bearish trade. You must run the risk graphs, and your broker may offer suitable software. Ask. The computer will give you a much better picture of risk than I can.

If you do that, I’d like to see one of those risk graphs.

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Implied Volatility and Beta


Isn't using IV (implied volatility) for statistics the same as using Beta as a measure of risk for stocks? I.e., if the stock dropped sharply and it's beta increases, but not the risk, it's actually a better price now. Same here – if the market declines today, does it really mean that tomorrow will be an even riskier day, as told by IV? If not it eliminates the need to trade fewer contracts on high IV times.



Beta and volatility are not comparable. Yes, in a broad sense you can say they measure a stock's volatility and tendency to undergo large moves. But the differences are very significant.

Beta MEASURES the PAST volatility of a single stock when compared with the volatility of a group of stocks.  IV is an ESTIMATE of FUTURE volatility for an individual stock (or group of stocks).

Beta is RELATIVE and depends on the volatility of it's comparative index (SPX or DAX) when we talk about volatility in the options world, it is an independent measure.  In other words, beta not only depends on the volatility of the individual stock, but it also depends on the volatility of the group.


Not the Risk

You said that the stock price declines, beta rises, and 'not the risk.'  Why do you believe that risk is less just because the stock is trading at a lower price? Okay, the total that can be lost is less because the sock price is nearer to zero.  So in that sense, risk is less.

However, risk is most often measured in terms of probability of losing money on the trade and not only in terms of dollars lost. Many traders believe a declining stock is more likely to decline further than reverse direction. That's the basis of technical analysis. Once support is broken, the bottom cannot be known. Trend followers jump on the bandwagon when stocks make big moves – in either direction.  I do NOT agree that the lower stock price suggests that owning the stock is less risky.

Remember Enron?  As the price declined, people bought the now 'less risky' stock – only to discover that risk had increased, not decreased.

There is a psychological rationale for buying stocks that fall.  Investors think about the fact that they were planning to buy at a price above the current level, so it must be a good, less risky purchase now.  Unless the stock has not broken support, there is no evidence that this is true.  There is always that feel good felling when you catch the bottom, but in my opinion, it's is too risky to make that attempt.


Getting back to beta

IV is an ESTIMATE of future volatility for an individual stocks or group of stocks.  Whereas implied volatility is very likely to increase as the market falls, there is no reason for beta to change unless it independently becomes more volatile than it used to be. Beta could decline if the individual stock moved less that its customary percentage of the index against which it is being measured.

When IV rises on a market decline, it is a fact that market participants believe that the market will be riskier tomorrow.  The evidence is clear and overwhelming. Traders pay higher prices for options – and those option prices are what determines the implied volatility.  Why do they pay those higher prices?  Because they are afraid that tomorrow will bring more downside.  They may be wrong, but that is the expectation. And IV is a measure of expectations.

Traders buy options when they want to insure a position.  They buy options when afraid.  They buy options when speculating.  Whatever the individual reason, the 'marketplace' buys options in anticipation of something bad happening.  That makes IV higher.

Remember when markets fall, they sometimes fall hard.  That's why people expect tomorrow to be riskier after a big decline. I see nothing wrong with that idea. Sure it's okay to fade the down move and sell a bunch of puts into a big decline.  You are getting a pumped price, but you are selling to the buyers who are far more afraid than you.  I have no reason to believe they are any smarter, but it does take courage to fade the crowd when selling into a falling market.  That's why there is a higher reward for option sellers who are willing to take the risk.

One reason for trading fewer contracts (as a premium seller) in a falling market is fear. The prices are attractive, we may be hoping that the decline will end, but there is that nagging fear of the huge bear taking hold of the marketplace.  I suspect it's not that higher IV per se that makes trades sell fewer options under such circumstances.


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Implied Volatility and Standard Deviation

Hi Mark, I have a few questions i hope you can answer.

1. Isn't holding a naked long call (as a result of locking in a profit or plain buying outright call) in general a bad idea? Reason I think so is because of the nature of IV: it mostly falls when the underlying is rising. So you have short theta and a big long vega moving against you.

And holding a naked put seems logical and natural.

2. Can IV be really considered as a Standard Deviation for a stock price? Same reasons to ask – why would a stock probability to be at a certain price range shrink just because the market moved higher? Why would it widen in case of a fall?



1.You are correct.  A rising stock price usually means that IV is falling.  Thus, any gains resulting from positive delta are diminished by losses from declining vega. Most novice call buyers miss that point.

You believe that it feels 'natural' to be short the put option and collect time decay. I also prefer to be short options (as a spread, never a naked option) because of time decay. However, I don't see anything 'natural' about being exposed to huge losses by selling naked options.  There is  nothing natural about that. [In further correspondence, you admit to having a big appetite for risk – and under those circumstances, selling options would feel natural].  Hedging that risk feels more natural to me – and that means we can each participate in the options world, trading in a way that feels comfortable.

However, the majority of individual investors – especially rookies – find that owning long calls feels natural: Limited losses and large gains are possible. That combination appeals to those who don't understand how difficult it is to make money consistently when buying options.  The chances of winning are not good when the stock must not only move your way, but must do so quickly. 

More experienced traders believe it makes sense to sell option premium, rather than own it.  Please understand: that is not a blanket statement.  There are many good reasons (hedging risk is primary) for owning options, but in my opinion, speculating on market direction is not one of them.

The problem with holding a naked (short) put option is that profit potential is limited and potential losses can be very large.  In addition, when the stock falls and you are losing money because of delta – IV is increasing and the negative vega is going to increase those losses. Although positive theta helps reduce losses – the effects of theta are often less than those from vega and delta.

Even though long calls and short puts are both bullish plays, they really serve different purposes.  Traders who want to own calls are playing for a significant move higher, while put sellers can be happy if the stock doesn't fall.  Put sellers have a much greater chance to earn a profit, but that profit is limited.  Selling puts is not for the trader who is looking for a big move or who wants to own insurance that protects a portfolio.

2. Standard deviation is a number calculated from data – and one of the pieces of data required is an estimate of the future volatility of the stock.

Yes, it appears that a rising market results in a smaller value for the standard deviation move, but in reality, SD decreases because the marketplace (and that is the summary of the opinions of all participants – the people who determine option prices) estimates (as determined by the prices and IV of options) that future volatility will be less than it is now.  You are not forced to accept that.  You may use any volatility number that suits to calculate a standard deviation move.

If you argue that it doesn't make sense for a mathematical calculation to depend on human emotions and decisions, I cannot disagree.  However, to calculate a standard deviation, it just makes sense to use the best available estimate for future volatility. Most traders accept current IV as that 'best' estimate.  That does not make it the best, it's just a consensus opinion.

If you prefer to use your own estimate to calculate a one standard deviation move, you can do that – as long as you have some reason to believe that your estimate is reasonable.


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