I started out my Group Coaching class recently by talking about how it may be a bit more difficult to find option trades than it was a couple of weeks ago. As you know, everything in options trading is a trade-off. If the probability to make money is good, the risk/reward is not so good. If the risk/reward is fairly good, most likely the probability is lower. The market may be a bit more difficult right now, so let me explain my thoughts.
IV Levels Have Fallen
Implied volatility levels have dropped drastically over the past couple of months. Take a look at this daily chart of the VIX (S&P 500 Volatility Index).
When the VIX drops with IV levels, option prices do as well. Credit spreads that were awfully tempting just a few weeks ago seem less of a bargain now. In class, we modeled out a few recently that really made no sense from a risk/reward standpoint. To me, the market is still quite volatile with gaps and intraday moves sometimes being very dramatic. I feel option prices do not match the level of overall volatility.
IV Skews Are Less Abundant
When IV levels are high, there are typically more IV skews available. For long calendars, an option trader prefers higher IV levels on the short option expiration and lower IV levels on the long option expiration. When IV levels are elevated, IV skews are more abundant. With IV levels dropping, it has been harder to find that IV edge. Now granted, there will be some IV skews with pending volatility events like the upcoming FOMC announcements.
Quarterly Earnings
Lastly, we are just getting under way with the latest quarterly earnings. If you are a TED (Total Earning Domination) trader, you are excited. If not, it can sometimes be a nuisance trying to avoid those landmines otherwise known as earnings announcements. Just be cognizant and check and double-check for any expected earnings before placing your trade. No one wants a nasty trading surprise.
Finally
That said, there are still plenty of opportunities out there to extract money from the market. But in the current conditions, you may have to consider different strategies from what have worked in the recent past. Happy trading!
John Kmiecik
Senior Options Instructor
Market Taker Mentoring
