Current Implied Volatility: Attractive to Buy or Sell?

Iron condor (and other premium-selling) option traders appreciate when conditions provide an added likelihood of earning a profit.

Such conditions are: high implied volatility and low realized volatility.  The former translates into higher premiums for the option spreads that we sell and the latter translates into a reduced probability of having the market make a major move. However, we are still subject to suffering through a relentless, non-volatile, one-way stock market.

Jared, of CondorOptions, offers hope that we are indeed in such an environment.  His (excellent) work includes publication of a weekly 'volatility tracker.'  His current stance:

"Where technical analysis might regard a VIX at 24 as somehow cheap –
especially in relation to its levels one year ago – any casual market
observer knows that, if anything, implied volatility in equities
remains on the high side. We simply aren’t seeing 1.5% daily moves in
the S&P 500, and until we do, traders should expect options to
remain overpriced."

Option premium may not appear to be elevated, but compared with how volatile the markets have been, premium sellers are getting good value for the risks taken.

With the September cycle coming to a close, those who have positions loaded up with front-month options will no doubt choose new positions that expire in October.  But I prefer option positions that expire later.  I'm going to go with November this time.  It's a tough choice. 

Per Jared's observations, it's likely the options are 'overvalued' from the standpoint that the final realized volatility is likely to be less than the options are predicting (implied volatility).  But the absolute value of that IV is not high enough to make selling longer-term options attractive.  Thus, as long as IV remains near these levels, 2-month options are more attractive for my comfort zone.

When you open new positions, be certain you are comfortable with the risk and reward potential.  Jared's data bodes well, but things can change suddenly.

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2 Responses to Current Implied Volatility: Attractive to Buy or Sell?

  1. Tom Clark 09/15/2009 at 6:27 AM #

    Mark,
    With the exponetial nature of time premium decay, wouldn’t it generally be better to sell the front month and on expiration sell the next month? Most of the money is made in the final week isn’t it? This way you have 2 ‘final weeks’
    Enjoyed your books and your blog.
    Tom C.

  2. Mark 09/15/2009 at 7:56 AM #

    Generally be better? No. In my opinion, there is no ‘better.’
    In return for the more rapid time decay that you crave, you must accept more negative gamma when trading front-month options. I am not willing to make that trade, although I recognize that most people are eager to do so.
    Any strategy that includes selling premium benefits from time decay, and for most traders, that’s the end of the story. I am not saying anyone is wrong because it is a comfort zone decision, but most of the time I want to avoid the large negative gamma that comes with being short front-month options.
    My trade-off – and am NOT saying it should be yours – is that I’ll take less positive theta in exchange for less negative gamma.
    If you are unaware of just how much difference that negative gamma makes, take a look at Table 18.4 and the discussion, in The Rookies Guide to Options. It’s a very important concept.