Volatility Decision Time? It’s Always Volatility Decision Time

What to do about volatility?  That is the question.  Has it fallen far enough to tempt you to own positions that are long vega (calendar spreads, diagonals, naked long puts and/or calls etc.)

It doesn't tempt me, and I'm going to continue to trade iron condor positions (with negative vega) which do well in periods of declining IV and vice versa.  But, I'm taking it gently and am trading fewer contracts than last year.  I am not going to gamble that the huge market volatility of 2008 is behind us – and safety comes first.

Recently, Adam at Daily Options Report has been pointing out that the market has been less volatile* than option implied volatility (IV) has been predicting.  When that's true, the probability of success when trading vega is on the side of the seller, not the buyer.  From my perspective, buying iron condors has been a winning strategy for 2009.

*This is not complicated:  Assume the IV of a stock or index is 50.  This means that options are priced so that if the future volatility of that stock or index turns out to be 50, then the options are fairly priced.  Recently, stocks are moving by less than IV predicts and option buyers are not getting 'their money's worth' of market movement.  Thus, they are paying too much for the options.

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2 Responses to Volatility Decision Time? It’s Always Volatility Decision Time

  1. rluser 02/13/2009 at 7:27 AM #

    I agree with Adam (btw that link requires one to be signed into google reader), and have been selling options with IVs of three to four times their historical volatilities. This has proven fruitful as it unfolds that they have been overpriced. In once instance an unexpected early put excerise resulted in an early reward (though not as great as if it had expired worthless).

  2. Mark Wolfinger 02/13/2009 at 7:54 AM #

    Thanks for sharing.
    The problem is ‘just how much I agree with Adam.’
    I’m selling premium by buying iron condors, but have been decided to limit the size I trade. It’s so temping to go ‘all in’ when things are working so well. But so far, I have resisted the temptation. I am unwilling to be exposed to a gigantic loss.
    Of course, I can always buy even more insurance…
    I think I’ll remain prudent – for now. How about you? Are you trading extra size these days?