“Chicken Licken” or the Volatility is Falling

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While surfing recently, I came across comments and questions from a small number of option rookies who are perplexed by the recent decrease in option premium. 

One lamented that he has been unsuccessful when attempting to sell options at prices that are equivalent to those he had been collecting in the past. 

I understand how frustrating this may feel to an investor who doesn't recognize how options are priced.  And even when it's understood that implied volatility plays a huge role in the pricing of options in the marketplace, the newbie has not been a market observer long enough to recognize that the volatility observed during the last few months of 2008, and the early part of 2009, was the highest it has been over the past 21 years (as long as the CBOE volatility index (VIX) has been published). 

Without that stock market experience, the rookie's observation of plunging volatility – from those record highs over 80 to it's current level near 30 – translates into rapidly decreasing option prices.  And those option prices 'feel' too low to sell.  That rookie investor is still searching for much higher option prices – prices that don't exist.

Our newcomers to the option world just needs a small history lesson regarding stock market volatility.  One glance at a graph of historical VIX levels is enough to send the message that implied volatility is not low, and that option prices are still higher than they have been, on average.  Below is a graph of VIX data from Jan 2007 through 5/22/2009.

VIX data


A VIX level of 30 is still 'high' by longer-term standards.  The big decision for all investors is whether to anticipate that IV will continue to contract or if VIX = 30 is going to be a volatility floor for the foreseeable future.

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6 Responses to “Chicken Licken” or the Volatility is Falling

  1. Hi Mark,
    Thank you for your recent comments to my questions, please don´t take them as I try to discredit your opinions see me as a pupil triynt to learn. I really apreciate your labour.
    I allways though live is not black or white, it deppends on your circumstances, that´s what I´m learning when you work with options.
    I´m really intrigued about what to do in theese moments like current as you mention in your last blog, because if IV goes donw will be good to start an IC, but what if IV grows as past moths???
    Also, I though you were an “only seller” but in your yesterday post you told you buyed when IV is low, but I wonder how do you consider those times thinking IV is not going to grow. To me predicting volatility movements seems as difficult as predicting price movements.
    Grateful, Antonio

  2. Mark Wolfinger 05/26/2009 at 8:34 AM #

    I understand why you are asking your questions.
    “What if IV grows?” All we can do is limit the risk we take if IV moves in one direction or another. You have three choices:
    a) Trade iron condors. That makes you short vega, and if IV increases, that is not good for you.
    b) Trade calendar spreads or double diagonals. That makes you long vega, and an IV increase is good for you.
    c) Owns some iron condors. Own some double diagonals. Own a portfolio that is vega neutral. This is much less risky than guessing if IV is going to grow or shrink.
    Yes, predicting volatility is not easier than predicting stock direction. But I must choose investments to own, and I am not forced to trade iron condors. If my guess is that IV is more likely to move higher than lower, then why trade iron condors? I may be guessing, but I can trade double diagonals if my guess is that they will be more profitable than iron conodrs. In truth, I trade a vega neutral portfolio right now. That’s because I do not know what the future holds for IV.

  3. slait73 05/28/2009 at 10:29 AM #

    Hi Mark,
    I´m happy to seen my questions and your answers are consider to advertise.
    Should be good to explain in a practical way how to pass to a vega neultral status when you are short vega, so you own an IC.
    Please it´s possible some examples?
    Thanks a lot.
    Antonio.

  4. Mark Wolfinger 05/28/2009 at 1:56 PM #

    see relply: blog post 5/29/2009
    Q and A. Going From Negative to Neutral Vega

  5. JCVictory 05/28/2009 at 6:45 PM #

    Mark,
    As a proud option rookie, I’ve been fascinated to see how much option prices have changed over the past month.
    You talk a lot about one’s personal “comfort zone” and it’s neat to now see how those decisions play out in my real time trading.
    + For me, is a 10 point wider RUT iron condor worth the $.40 less in premium?
    + Should I positions be established at 13 weeks or 11 (or sooner)?
    + Should I add other positions to reduce volatility and/or price risk?
    + How will I work an order to get the most advantageous fill?
    No “right” answers – just personal ones — and that’s all part of developing one’s comfort zone.
    A great journey of discovery . . .
    James

  6. Mark Wolfinger 05/28/2009 at 8:14 PM #

    Sounds as if you are having a good time. Can’t do better than that.
    Thanks for sharing.