Half Full or Half Empty?

Implied volatility came crashing down in recent days.  That's good news for premium sellers and bad news for option owners.  If you own options, it's likely they lost value, even if the stock moved in the right direction for your option position.  But if you intend to buy options, you are going to like Monday's prices (barring a big surprise opening).

There is one important point to consider, and Adam had already mentioned it:  "The next 17 calender days consist of 3 weekends and 2 holiday shortened
weeks, and lots of champagne and disinterest in stocks. No one in their
right mind would pay full fare prices for so much time. Hence bids get
lowered, offers get lowered, but time stays the same. It gives somewhat
of an illusion of a volatility implosion, when it's more of a calender
quirk
."

***

December index options expired at the opening yesterday morning (equity options expired at the end of the day), and it was time for me to establish some new iron condor positions.  My preference is to buy iron condors that expire in February and/or March.  I already own some of each, but I add more after each expiration.

The good news is that my open positions have done well.  The bad news is that any new positions must be opened at prices that compare very unfavorably with recently opened positions.   The severe decline in the implied volatility of RUT (and all other) options is to blame.

Thus, I ask: is the glass half full or half empty?  Overall is this good for investors who sell option premium?  I believe it's good news.  If we are truly entering a period of reduced volatility, then owning iron condors is much more likely to be a winning strategy.  And if the price I must pay to have a much better chance of earning profits is that those potential profits are smaller than they were a month ago, then that's a good trade-off.  Market volatility may increase, but it's less likely during the holiday season.

There is no way to tell if market volatility is on a longer-term decline, or if this is merely a temporary downturn.  But we will learn the answer soon.  No one expected the extreme volatility to last forever, but it's also true that no one knew if the market would become even more volatile before finally settling down.

The decision for all of us is:  do we buy or sell premium next week?

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2 Responses to Half Full or Half Empty?

  1. Russ Abbott 12/20/2008 at 6:22 PM #

    Hi Mark,
    Do you really buy iron condors? I’m surprised to hear that. Your comments on your next post “Closing an Iron Condor Early” suggest that you don’t. It must be that when you say you “own” some iron condors you mean that you have sold them. Is that so, or am I confused?
    — Russ

  2. Mark Wolfinger 12/20/2008 at 10:26 PM #

    Russ,
    I know it’s anti-intuitive, but when you buy an iron condor, you sell the call spread and sell the put spread.
    When you buy a condor, you either:
    a) Buy a call spread and sell a call spread with higher strike prices (ex: Buy the Jan 75/80 call spread and sell the 95/100 call spread).
    b) Buy a put spread and sell a put spread with lower strike prices (ex: buy the 160/180 put spread, sell the 120/100 put spread).
    When you buy an iron condor, you collect a cash credit.
    When you buy a condor, you pay a cash debit.
    That’s the terminology – and as I’m sure you know, I didn’t invent it.
    Mark