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The Best Strategy When Volatility Is High

This is one of the most important assets in the option-trader’s toolkit…

Volatility is back… duh.

One of my top predictions for 2018 was for a return of volatility. That prediction really wasn’t much of a stretch. Periods of low volatility are ALWAYS followed by periods of high volatility. So, after an entire year of a declining Volatility Index (VIX), calling for a higher VIX in 2018 was like sinking a one-inch putt.

Trying to profit by trading options when the VIX is high is quite a bit more difficult. Let me explain…

When the VIX is high, option premiums inflate. That means option buyers are paying premium prices to buy calls and puts. So, it takes a larger move in the underlying stock in order to profit.

Meanwhile, sellers of calls and puts are collecting a higher-than-normal premium. So, they’re collecting more money up front. And they have a larger hedge against an adverse move in the stock.

In this sort of environment, traders should be looking to sell options rather than buy them.

Rarely do we get such a clear example of how the VIX affects option prices as we saw over the past few days.

When the stock market rallied on Monday and the S&P quickly gained 36 points, the Volatility Index (VIX) dropped nearly 12%. As a result, option premiums dropped as well.

For example, the SPY February $265 calls – which closed at $2.28 on Friday – rallied and closed at $2.86 yesterday. That’s a decent gain, but it seems somewhat lacking given a HUGE 36-point gain in the S&P 500.

In a low-volatility environment, a 36-point gain in the S&P 500 would usually be enough to double the price of the call options.

But that didn’t happen. Traders who bought this expensive call option made $0.58 per share.

Meanwhile, folks who sold put options on Friday did a whole lot better.

For example, the SPY February $265 puts closed Friday at $5.39. After yesterday’s big rally in the S&P 500, this option closed at $2.41. That’s almost a $3-per-share gain. That’s a much larger profit by selling uncovered puts than traders would have earned by buying calls.

The ability to sell uncovered put options is an important strategy for any options trader. In a period of increased volatility, traders will make far more money by selling uncovered puts than by buying speculative call options.

If you want to make money trading the stock market in 2018, then you absolutely need to be able to sell uncovered puts.

Pick up the phone, talk with your brokerage firm, and tell them you want to sell uncovered puts.

It’s likely to be the best-performing strategy in 2018.

Best regards and good trading,

Jeff Clark

P.S. Even in last year’s low-volatility environment, Delta Report readers profited from selling uncovered puts over 20 times. And now, with volatility returning to the markets in such a big way, we’re excited to continue putting this strategy to work.

To learn how you can take advantage of this winning strategy as a Delta Report member, click here.

Reader Mailbag

Today, a mixed bag of trading stories, thoughts on gold, and responses to last week’s stock action…

I really appreciate all of the good info you provide us. I look at your comments several times daily.

Regarding the SPY call… I got filled at $1.85, bought more at $0.52 and again at $0.15. I was able to sell for a profit at $0.91. The trades worked out well.

I like getting paid to trade. I prefer the bullish put sell recommendations. Thanks and keep up the good work.

– Dennis

 

Thanks for inquiring.

Long story short, one fateful day last July, when I first began to trade options, unbeknownst to me, I blundered big time or so it would seem! For quite some time, long before I started to trade options, I had been trading gold stocks like Agnico Eagle (AEM), Barrick (ABX), and Goldcorp (G) with confidence and success. Typically, I would buy and sell 1000 shares of each gold stock at a time on my margin account.

But, on that fateful day in July last year (or was it June?), I filled in a form thinking that I was placing an order for 1000 shares of AEM (Agnico Eagle). Now believe the unbelievable: without realizing it at that time, it turned out I was actually placing on order for 1000 calls of AEM. I did not realize my error until I checked my portfolio later that night. My broker told me only 47, instead of 1000, calls were filled and I was stuck with them. However, rightly or wrongly, I could not help thinking at the time I was somehow “finagled” into making that error. i.e., I was victimized.

Oh well, it is not unknown that some rogue brokers at times operate in cahoots to “screw” an unwary beginner for their (brokers’) mutual benefit.

Fortunately for me, in the course of time, I was able to recover my $7,000 loss and then some and I look forward to making more money with your help/guidance. Thank you.

– Lawrence

 

I thought you and others thought silver and gold were going up, but that is my biggest loser. Otherwise I am glad to be out of this wild market thanks to you.

– Van

 

Sincerely appreciate Saturday’s Delta Direct. You are a wise mentor.

– Harvey

 

Just read your Saturday post. As always, thank you for your insight, candor, and common-sense approach to the markets.

I am sure that the S&P has dropped more than 3% in less than 3 hours over the history of the market … ’87 et al. But, how many times has the S&P increased 3% in less than 3 hours in a single day like we saw yesterday? Your reminder that we are witnessing history spurned the question.

– Pete

 

You said: “At 2532 the S&P was trading 160 points below its 9-day EMA. It was 185 points below its 50-day MA. In 35 years of trading, I have never seen that happen before. That’s a record-breaking oversold condition.”

In terms of absolute points, I can see that it is true. But what about on a percentage basis, 160 points is only about 6% below 2532. Is that a “record-breaking” oversold condition?

You are right that Friday was gut wrenching, particularly when the trailing stops are triggered. I kept my “discipline” and sold the stock. But I keep on wondering whether I am getting whipsawed. Thanks for the reassuring words that this may be the bottom.

– Charles

As always, don’t hesitate to write to us with your trading stories, experiences, questions, and suggestions. Remember, while we can’t offer personalized investment guidance, we read every comment we receive. And we love to publish your feedback, positive or negative, right here in the Market Minute.

You can send it right here.