Santa delivered up stock market gains thru the end of 2014. But do lower prices mean Santa has blown town in favor of a well deserved rest? Will stock prices continue higher this year?
As I mentioned on this blog on December 07, 2014, Santa did indeed squeeze his rump down your chimney and left something you can use for a while. No, its not that 20 year old Macallan single malt or the GoPro camera to video you outdoor exploits.
Santa may have left town to work on his tan, but he gave us a gift that may keep on giving. Yes, that’s it. Higher sustained Implied Volatility.
THE FOLLOWING ARE EXCERPTS FROM THE DECEMBER 07, 2014 BLOG POST
“One of the best things I can think of would be the gift of higher implied volatility in the major market stock indexes. But will we see it? I believe so. We must get ourselves prepared for that inevitability. Below is a chart of RVX. This is a good example that holds true for the other indices we trade.”
” How do we prepare ourselves for a higher VOL environment? Here is a short list of what I am going to be doing. Remember along with higher IV in the options, there is also a corresponding gain in Statistical Volatility (SV) which means there will be larger swings in the daily and weekly price movement of the underlying instrument. Large up/down moves that overlap each other is ideal, however I’m going to be guarded for the stuff that can hurt us. Namely large protracted moves with in one direction with high momentum.”
1. I want to be neutral to long IV (at a minimum). Neutral IV means that the Vega of a position should be about even with Theta on a daily basis (1 to 1 ratio). Long Vega means that ratio would be more like 1 to 2. Really long IV is where the Vega of your position is 3-4 times the daily Theta.
2. I want to consider to start using longer term insurance of my trades in case of any unexpected large moves. Insurance could be buying put debit spreads out-the-money (OTM) in distance expiration’s. The cost of any such debit spreads would be spread out of the time of multiple trades.
3. I want the edges of my profit zone to be larger than the center of the profit zone.
4. I want to shy away for trades that requires 30-40 days to come to fruition. That does not mean that I will not have position strategies in expiration cycles that are 30-60 days in the future, but I will use Combination Strategies embedded into the position in an effort to earn reasonable returns within the shortest time period possible. Less time in the market translates into less risk, if done properly.
That’s a short list that would be a good start for the serious trader.
NOW I HAVE SOMETHING TO ADD TO THAT LIST
In a sustained higher implied volatility environment, butterflies are a good tactic because they are naturally skewed to the downside for protection and they are negative Vega as the market goes up. The key is to not allow your Gamma to get too large. How do we do that? We trade for the bottom half of our profit graph.
A good butterfly trader will modify the butterfly as it gets closer and closer to expiration. The modification should be along the lines of the 4 points in this article.
“The Options Boss”