As you know, my approach consists first in locating the best performers for he last 90 days before that date and then select amongst them those that are closest their 52 week high. UNH is 10th on the list here.
Presumably you would have gone down the list to find the stock with the appropriate characteristics to enter a PCRCC trade. First, the IV is near a 2 year low, but it seems poised to jump. If the volatility is to remain low, we will be able to survive a volatility crush and have Theta, and possibly Delta work for us. It the IV jumps, Vega will work for us as well. This applies to all trade of this type.
Next, we make sure the SV compares favorably with the IV. This is to make sure that the stock will not begin to trade in a narrow range with lower and lower volatility. I like to compare the 7-149 day IV with the 6 day SV.
Please remember that we are going to sell front month options, so we want those options to be expensive in comparison to the ones we are going to sell. Compare the 7-20 day IV with the 6 day SV. If the ratio is above 1, the options are not “cheap”. So it is OK to sell them. If they begin to lose volatility value, they will depreciate before expiration.
We are going to sell options 3 months away, so we should look at the 61-90 day IV compared with the 6 day SV, to make sure that we are not buying expensive options that may rapidly lose value.
Now, let’s enter the trade, assuming that you have about $20,000 to invest. Verify that the trade has an appropriate format. Assume that you’d be able to shave a little bit from each leg of the trade. That should not be difficult, if you have a good broker (I use OptionsXPress, but feel free to suggest others here). Note that the volatility is on the rise.
Let’s fast forward the trade to 4 days before expiration. As you can see in the chart below, volatility has spiked and that reflects in some profits. Proximity to expiration of the front options represents a decision point. Here are the basic rules to deal with volatility spikes:
If the stock is at the top of its range or declining: sell front month calls.
If the stock is at the bottom of its range or bouncing up, sell front month puts.
If the stock is trading sideways, you should sell a prudent number of calls and puts that will not alter Delta.
In the UNH example, I have to roll over the front month options, which I prefer to do days before expiration. The next month options are still expensive (high volatility), so it is appropriate to sell those. Because the stock price is moving sideways, I sell both calls and puts. Regularly, I short ½ the number of longs. In this case I increase the shorts to ¾ of the longs (both calls and puts). The rollover point is ideal for increasing the number of shorts. You want to avoid making many adjustments, which increase the total cost of the trade. Here is the resulting trade:
By June expiration, volatility is picking up again.
Although the stock rallied slightly above the strike price, the double top signal a possible reversal or sideways motion to come. I simply roll over both puts and calls. I expect both Vega and Theta to work for me in this trade.
As I rollover the trade to July, my debit is reduced significantly from the original $20,000 to below $6,000. My profit is now larger than my debit. Both Theta and Vega are positive, and Delta will bring some profits in, should the stock move down.
Please follow this trade to its conclusion, by rolling over shorts and possibly increasing the number of shorts until Aug. expiration, at which time we would leave the trade. After you have done so, feel free to comment below.
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