How to view the entire chart:
1. Try clicking on the name of the most recent article in the column on the right. This will remove the "Archives" list.
2. Try right click on the chart itself and open it on a separate window.
I am sorry that I cannot always make the chart small enough to fit neatly on the left column. I want you to be able to see the details I want to point out.
I Hope this helps,
Juan
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Our friend "StrangledCondor" suggested we discuss calendar spreads and offered his own guidelines. Let's see if we can find some good opportunities using his technique.
The first step would be to do a search to pull out some candidates. I gather he uses "skewfinder" from optionetics platinum. Using the backtesting capabilities I marked the date 5/25/06 and entered the following setting on the skew finder:
We are selling volatility, so a high skew between front and back month would mean that we would find stocks with IV>50% in the front month options and less than 40% in the back month options. Here is the list of candidates generated by '"skewfinder":
We can rule out candidates with not a great deal of skew. I wouls suggest a minimum of 5%.
Then we select candidates with low volatility in the back month option, that is a maximum of 40%. In this example we have as candidates: IMCL, PKX, OSI, and SKS. The front month options for IMCL have an IV of 57%, which is quite high, compared to the back month IV whihc is 35%. In fact, IMCL has the larger skew of the selected group, except fo r5 others with either too high back month IV or two low front month IV. So I have selected IMCL as my best candidate.
Here is the selected trade: Note that the resistance and support points are well contained within the breakeven points. Further, as the rules StrangledCondor call for, the whole value of the front month option is premium. The options are OTM, so the preium is $2.1 to 2.3, in this case, it is more costly than the whole spread which is only $1.1.
The volatility clearly shows why this is the case. The front month options are quite expensive compared to the Nov. options.
The result is that in about 3 weeks, this trade would have given us >60% in profits. While the long-term options lost hardly any value, the front month lost most of its value.
Once the front month options expired you have finished the long-term options. Only costing $400 in total these 5 options may provide a path to more bullish trades. You could still simply exit the potions, or rollover the shorts to the following month.
The longer we hold this trade, the more we risk that IMCL would exit this trading range.
A PCCRC would work like a calendar in many ways. What I like about the PCCRC is that the trade is open to profits from a large rally or a large decline. However, the effect that we have seen her with the IMCL calendar trade, is is also quite possible with PCCRC, that is, to make money based on Theta.
16 comments:
What what the reason for the high IV on the front month option.
This is always a risk with high IV that the stock could gap below your breakevens
Hi
One final question. What is the reason for only looking at trades with IV >50% for the front month and less than 40% for the back month.
Why these settings?
Thanks
Newtrader1,
Welcome to the board. I am sure that Juan will answer your question too, but I will give you my ‘take’ on the set-up.
RE: “What is the reason for the high IV on the front month option?”
To try to obtain an ‘arbitrage’ between selling over priced front month options, compared to lower priced back month options. This also ‘in part’ answers your other question;
“What is the reason for only looking at trades with IV >50% for the front month and less than 40% for the back month?”
If you were also asking ‘why those percentages (40% and 50%) in particular?’, I can only conclude that this is ‘a rule of thumb’, rather than being scientifically based.
RE: “This is always a risk with high IV that the stock could gap below your breakevens”
To be honest, I am not sure what you mean here, so please explain further, because you may be bringing something to the debate I am not aware of. I am no expert on all this. **Smiles**
Thanks again.
In my experience I have found that if there is a skew between the front month and back month options it means there is upcoming news on the stock e.g. earning, FDA announcements etc.
I was wondering was there any news on the IMCL stock that caused the skew in the 1st place.
If you have an IV crush on the position where the back month IV drops by a lot this will narrow the breakevens and could cause the trade to then be outside the breakevens
Hope this makes sense
Hi Newtrader
Every time you enter a trade you should consider direction, of course, but also volatility. If you want to enter a long call, you should make sure that it has low volatility compared to its 2 yr. IV chart. If IV is too high, you could "spread" the trade by selling options at a higher strike price, hence reducing the cost by mitigating the effect of IV.
It follows that you could take advantage of situations in which volatility is different at different strike prices or different expirations. Front month options, as you well point out, being subject to the pressures of news items, could have higher volatilities than the second or back month options at the same strike price. Hence the calendar. Your job is to locate stocks with volatility skews in the front month, hence SELL HIGH volatility and BUY LOW volatility. For what I have seen, calendar traders don't sit around rolling over the calendar month after month. Instead, they focus on the volatility and wait until either the long-term options spike in volatility, or the short-term options decline in volatility.
You are right that if a news item shows up, then Delta may negatively affect your whole spread as the stick may jump outside of the breakeven points. That is your risk. With the calendars your are counting on Vega and Theta do earn you some profits, but your risk is on Delta. It follows that the volatility may be high as the news item is pending. Shortly after the news are out, volatility declines and your chance to make money quickly vanishes, if the stock jumps or declines rapidly outside of the profit zone.
StrangledCondor has stated that he never trades on one of these anymore than he can afford to lose. Perhaps he trades a few of these and he is confortable with the risk that it suggests to have to get out of the trade right after the jump in order to cut his loses. However, there is something to be said for a clear exit strategy, when the trade is a loser, and is not likely to turn into a winner. Perhaps he will comment on that.
The volatility skew strategy has been used by others in the selection of Iron Condor candidates. Take a look at the link below, This is a free webinar from Chartbenders. In it we are shown how to use their tools to recognize expensive options. Although one could enter a short strangle to take advantage of such situations, you simple avoid being "naked" by buying cheaper calls (higher strike) and puts (lower strike). Perhaps this strategy would mitigate you concern about a jump in Delta, if you open the Iron Condor wide enough. I would even go further and sell front month options like they do, but BUY second or back month options to benefit from Theta too.
http://www.chartbender.com/cbwebinar20060518.aspx
I think like you do in that I always expect the worse and a big jump in a stock with high IV options should be expected. This is why I entered a PCCRC on IMCL. I have actually done already 2 trades with >$4000 profit. Further, I am still open to some jump or strong decline in the stock price (Delta gains), gains in volatility of my back month options, or simply Theta gains until expiration, should the stock continue to move sideways.
Thanks for your contributions Condor.
Newtrader, IV skew is subjective to the trade. Take this one for example:
http://tinyurl.com/pj4gy
This trade had very little skew at the inception when I put the order in, yet it worked out fine. Skew in the front will narrow the spread between months, but at the cost of possible movement. Look ahead for news events. If there's one, don't trade it. Also, there is no rule of thumb about IV. IV in the lowest percentile is preferable, as there's a less chance of an IV crush, but it doesn't have to be so.
BTW, for those that don't have Platinum, just 0 out the legs on 06/02 and hit analyze for the link to see the trade on the closing date.
Juan, RE exit strategy. It depends on how much I paid for the calendar. For example a 20c calendar I probably will risk the whole amount, as after slippage and etc it's not worth getting out. That won't be the same for a 70c calendar gone to 40c. The position sizing is that given a black swan event or whatever, you don't blowout your trading account.
I just realized that non-Platinum users may not be able to change the date in the upper right corner to 06/02 to see the trade. Perhaps Juan can post the trade as my HTML is not up to par.
I also have to add this since I reference Platinum a lot. Disclaimer: I am not trying to push Optionetics Platinum to anyone here. It is merely the analysis software I use.
Well, the rule of thumb for me on volatiltity is as follows:
1. Look at the 2 year IV chart. This historical view will let you see what it high for that particular stock.
2. Low volatility is below 30%, high IV is above 50%.
3. A good skew is 15% or more.
Of course every stock is diffrent, and biotech stocks are notorious for their high IV.
Condor: your platinum links are fine. No one has complained yet about our use of platinum, but one can certainly enter a description of the trade and date like this:
JNJ $50 Calendar: May 16, 2006.
BTO 1 Jul 60 put
STO 1 Jun 60 put
If anyone knows of a source of risk graphs other than Platinum in which to look at backtests, please share.
Obviously, the JNJ trade is in a different category all together, because there is no IV skew to begin with. Rather, JNJ is a low volatility stock. This would probably have to do with its blue chip status. No individual news could affect a stock like this too much. Toward expiration, the volatility may increase, but in the front month is Theta decay the greek with the highest impact.
I recomend platinum as the best product Optionetics has to offer. I also think there is nothing better for backtesting, paper trading and to follow complex strategies that we discuss here.
BTW, those interested in Elliottician's Elliott wave analysis program, they are selling it again. Please contact me and I will send you the information of a contact at Elliottician.
Paperprofit1@mac.com
Mike here, have to dig out my password and name....
Anyway,I was looking into NXTP and my combo of elliott and contrarian tell me that the new 5 year high that has stalled out is a great chance to buy the AUG 27.5 Put, yet the probability calculator tells me that there is a 0% chance of this happening.
Anyone have any thoughts on this stock. Until now, I have not ever looked at it, but the charts speak to me that it will go to a down trend soon.
http://biz.yahoo.com/ap/060620/sprint_nextel_acquisition.html?.v=1
Mike!!! ALARM!!! DO NOT TRADE OPTIONS IN ANY STOCK WITHOUT CHECKING THE NEWS.
Nextel is been acquired by Sprint. There will be no volatility, and certainly no decline in stock price.
Oops, too late.
Lesson learned, on to the next. . .
If by some chance it drops a few bucks, and I am sure it will not, I will do well.
Guess that system is not fail-proof.
Many of these stocks on this list have made wonderful gains in the past 6 months. So, how can one go about finding these before they make this move? Are there any key things to look for?
Also, I am reading "Market Wizards" and one of the traders talks of a ticker on the S&P. He goes on to say that 2 - 4 times per year there is a tick that moves over or under a specific number (I think it was 4000 but I am not sure) anyway, he said that when he gets this signal, he knows that there is a sharp up or down trend in the next day - 7 weeks.
Does anyone know how to look for the tick indicator?
At 9:41 AM, Mike said...
Oops, too late.
Lesson learned, on to the next. . .
If by some chance it drops a few bucks, and I am sure it will not, I will do well.
Guess that system is not fail-proof.
Juna: Sorry about that Mike. Just take your time, and check Yahoo financial for all your trades. The news could make you change your mind immediately!!
At 9:53 AM, Mike said...
Many of these stocks on this list have made wonderful gains in the past 6 months. So, how can one go about finding these before they make this move? Are there any key things to look for?
Juan: What list are you referring to? if you refer to some of my trades, I specifically look for high fliers. I don't care that they have just hit new highs. The PCCRC works best in high fliers because volatility is low and tends to be low. Then I can make gains on DELTA. In the last month or so, the declines in most stocks have increased volatility. I makes sense to enter PCCRC in stocks that would decline with high IV. These IV increases result in Vega gains.
Mike: Also, I am reading "Market Wizards" and one of the traders talks of a ticker on the S&P. He goes on to say that 2 - 4 times per year there is a tick that moves over or under a specific number (I think it was 4000 but I am not sure) anyway, he said that when he gets this signal, he knows that there is a sharp up or down trend in the next day - 7 weeks.
Does anyone know how to look for the tick indicator?
Juan: It would be good to give us the specific reference. Is this from a book? enter the author, page and edition, in case any of us has experience with that. The book (?) does not sound familiar to me. Perhaps someone else could comment.
Juan: The book is called "Market Wizards" the author is Jack D. Schwager. He interviewed several top traders to see what makes them tick. The trader in reference is some farmer whos name I do not recall. He developed a system to find when the S&P would fling up or down and would do very short term trades based on this. He seemes to make the kind of profits I am looking for by doing so.
By memory only: the way he described it was if it trades from 1350 - 1353, each time it would move the spring board would have more tension, then it would jump to something like 1356 in an extremly short time." (Hope I got that right) - He also mentioned that this only happens 2 or 4 times per year. (I will try to study the charts to see if I can see what the heck he is talking about).
The list I am talking about is the optionetics vol skew that is posted in this section of the blog. I looked at all stocks and many had large moves in a 6 month period. I was looking to find out if there is a way to know when these stocks will make this rocket launch.
Being that my trade this morning was a wopping $5 per contract I did not loose much of anything, it was a long shot, I should have know just from the pricing, but I prefer to use charts and angles to forcast the market. (I am still in the test phase but do not mind throwing down a few bucks to try while I learn.)
Update:
SPX on Nov 15-25 2005 went from 1230-1270
May 16-18th 2006 went from 1290-1262
I think those are the kind of moves this trader is talking about and is able to know when they will happen based on hom many ticks above or below the neutral range the SPX is currently at.
Anyone have thoughts on this...?
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