Tag Archives | low implied volatility

Complacency, Low IV, and Buying Put Spreads

Hi Mark,

Thanks for the thoughtful and useful response. Actually, you always do
respond and they are thoughtful and useful– this trifecta, if you will,
is not often seen, especially on the web. Thank you for it.

Thank you JB

I'm not sure I understand in your response item #6, in Delta Neutral
Stock Replacement thread. If IV is low, there is unjustified complacency
in the market, as I understand it, and accordingly the market and the
stock are vulnerable to a decline. 

"Unjustified" is always going to represent an opinion, not a fact.  Right now IV certainly appears to be low from the perspective of the past two years.  However, market volatility -as measured by realized volatility – has been even less.  In other words, one could reasonably argue that IV is too high. 

If you anticipate a market decline based on an unjustified low IV, I could argue that we should rally, based on the fact that IV is higher than realized IV and that options are overpriced, not under-priced.  I am not making that argument, nor am I bullish.  It's just a discussion point.

Low IV, and market complacency, do not always result in a down market.  Options can remain under-priced for years.

Buying puts or put spread (I am
meaning the spread is buy higher priced put sell lower priced put) is
best done in a low IV environment and has the built-in stop-loss
mechanism of limiting the loss–obviously to the amount paid. I thought
this was a strong point in Josh's method. 

I agree with your definition of buying a spread.  I agree that Josh should cover put spreads sold earlier when IV feels low.  And it is a strong point of his.  However, taking the next step and buying extra put spreads is another story.  You are suggesting that if the spread is cheap enough to cover a short, then – in this scenario – it's cheap enough to go long that spread.  I don't buy that argument.  Covering a short position accomplished two things for Josh.  He locks in a profit, but more importantly, he eliminates further risk.  Buying extra spreads to get long adds brand new risk.  You become delta short and vega long.  there is nothing wrong with that – as long as that's the play you want to make.  I am not willing to get short based on your belief that IV is low and that investors are complacent.  I have no argument if that's your trading plan.  But I do not believe stocks must fall.  If this market resumes its non-volatile ways, IV will decrease further.

I'm taking a chance here – writing this Sunday night before the market opens for the week.

Would a call spread (sell
higher priced, buy lower priced) be of less concern?

No.  Selling a call spread and buying a put spread are equivalent positions, when the strikes are identical.

What are some good and simple ways to play the "low IV, expect a decline
in the underlying asset scenario."  I am making the assumption that a
market decline is almost always accompanied by a rise in IV. Is this a
bad assumption – one that is likely to "bite" me? 

Simple methods for the scenario you anticipate is going long vega.  You can do that by buying options or buying spreads.  I'd avoid buying ATM calendar spreads if you anticipate a decent market decline.  But you can also buy OTM put spreads at low IV.

Your assumption is a good one.  It's been a long time since implied volatility failed to rise on a market decline, or decline on a market rally.  Things probably be this way forever, but there is no sense guessing when that specific trend will end.

I know that for the most part selling spreads has better overall outcome
(outcome = expected value (x) gain/loss) but I am thinking of this methodology as an insurance type of play and one pays for the insurance. 

JB, I don't see that selling spreads is any better than buying spreads.  You must remember that when the strikes are the same, selling a call spread is equivalent to buying a put spread.  Some traders prefer to keep things simple and always sell (or always buy) spreads.  But I see no reason to do that.

Thanks. And all the best, as always. 

And to you, JB.  Thanks for the question and follow-up.


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