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The VIX, otherwise known as the investor fear gauge, is up more than 200% since the widespread market sell-off began last week. For most investors, the deep sell-off means lots of red.
However, for those of us who sell options for a living, we thrive during times of heightened fear in the market. I will be discussing the strategies I use during times of uncertainty in my upcoming webinar on Thursday, Aug. 27 at 12 p.m. EDT.
As options traders, we welcome fear in the market. In fact, more specifically, as options sellers we thrive on fear. We stay clear of market prognostications and focus on what’s truly important: making money.
Don’t get me wrong, I enjoy being entertained, but I save that for truly creative forms of entertainment, not a market pundit guessing which way the market is headed.
Remember, the stock market is 98% marketing. Why do you think we have endless opportunities to listen, watch or read anything we want about the stock market? Because the latest and greatest is what sells.
As someone who believes in the efficient market theory, I couldn’t care less about what other people have to say about the market. As Eugene Fama – American economist, Nobel laureate in economics and widely considered the father of modern finance – states, “I’d compare stock pickers to astrologers, but I don’t want to bad mouth astrologers.”
But I digress … back to why we, as options traders, should embrace fear in the market.
It’s called volatility, and it’s one of the key factors when trading options. Volatility – more specifically implied volatility – is a crucial element both in options pricing and in the profitability of any options trade.
Fear and volatility go hand in hand. Simply stated, as fear in the market increases, options prices increase.
For example, look at the recent drubbing in the SPDR S&P 500 ETF (NYSEArca: SPY).
The ETF has experienced a sharp decline due to ongoing geopolitical concerns, among others market-related worries. As a result, implied volatility, as seen through the VIX, has pushed significantly higher.
The sharp increase in implied volatility means we can sell options in SPY for significantly higher prices. As options sellers we love selling options for higher than normal prices.
So naturally, as a contrarian, I absolutely love when highly liquid, low beta stocks or ETFs take a hit.
Let’s take a quick look at a potential trade I might make in, say, SPY.
With SPY currently trading for roughly $192.50, I can sell the October 180/178 bull put spread – with a probability of success over 72% – for roughly $0.40, or a 25% return. The SPY would have to move 6.5% lower by October expiration in 53 days for a loss to occur.
If the trade seems too aggressive for your liking, you could always move your strikes lower to increase your margin of error. Given the current market environment, I think it would probably be a wise idea. I will be going over a similar trade in my upcoming webinar.
Again, an increase in market fear means an increase in implied volatility, and an increase in volatility leads to higher options prices.
Ultimately, as an options seller I really don’t care where the market is headed, as long as implied volatility is above historic levels. In 2013, those of us who sell options for a living struggled as implied volatility was at historic lows. But the 30% gain in the S&P 500 in 2013 was an anomaly, something that we need to recognize when we think about our expectations for the performance of our buy-and-hold portfolios.
Since that historic market feat of 2013, options sellers have once again thrived. Just look no further than the year-to-date performance of the two credit spread portfolios in my Options Advantage service. We’ve made over 100% in our vertical spread portfolio and over 160% in our weekly portfolio.
I recently received an email from an Options Advantage subscriber who has had similar success this year:
“I have been trading with you since the beginning of Dec. 2014, I am very pleased.
I have used others over the past 3 years with mixed results but I have done a total of 29 trades with you and only lost on 2 trades, that is pretty amazing. One of them was the AAPL trade in Jan/Feb but we won’t talk about that. I understand that is going to happen now and then.
I feel very comfortable trading with you and your trading emails are very detailed and answer all the questions. I have been using another who trade weeklies, with mixed results, so I am going to pretty much just stick with you and forget about using anybody else.
I just wish we had more trades, especially on the weeklies. I know you say it’s a marathon and not a sprint. Sometimes I have had a frustrating time with that … but I’m sure that is why I have only lost on 2 trades out of 29. Keep up the good work. … And if you want to trade more I am there for ya!”
I’ve been receiving lots of similar emails recently. But, I’m not going to take all the credit. Proper credit must go to the return of volatility back to normal levels and the mechanical system I teach to my subscribers. And now that volatility has reached heightened levels, more opportunities should occur.
Again, on Thursday I will be giving another monthly presentation on how I trade options in any type of market environment, with an emphasis on what we are currently experiencing in the market. I will be discussing the same strategies and mechanical system I have used over the last 17 years with great success, regardless of market direction. These are the same strategies that have allowed me to outperform the market in 2015.
If you would like to learn how to implement these strategies in your portfolio, please make sure you sign up for the presentation. If you can’t make it, no worries. We will send you an email of the discussion shortly afterward. Click here to join the event!
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