Gigantic Volatility: Hard to Find PCCRC Candidates

My rules of entry of the PCCRC are quite stringent, so readers have been expressing frustration about finding candidates in the current environment that includes the most significant Volatility Index since the crash of 1987.

Here are the entry conditions for the PCCRC:

The IV of the back month options must be ≤ IV of the front month options.
The IV of the back month options must be < 40%.

These two rules are essential to profit in case of a decline in the stock value (usually accompanied by a spike in volatility) and to avoid a volatility crush, should the volatility begin to decline. This decline could occur unexpectedly, so we do not want to hold a PCCRC with excessive volatility.

I have described several scenarios in which the PCCRC would be an appropriate strategy. I call them search conditions because we can use technical analyses software to locate the trades:


Post earnings jump of 10% with a decline in IV, and raise in earnings guidance.
High fliers or the best performing stocks of the last 90 days.
Break outs to new highs, stocks that go up to new highs after several weeks of decline and reversal.

Such candidates were abundant just a few months ago, but with the strong decline in the stock market, they are few and far between. Although the market decline has proven the value of the PCCRC strategies I describe, the question is, would it be a viable strategy going forward if the markets are so overextended in volatility and price declines.

I would argue that today, more than ever, the PCCRC would be the strategy of choice. On one hand I have demonstrated a phenomenal track record with the publicly traded paper trading account I have been posting in my private group (97% increase since June 2007). On the other hand, the entry and search conditions will keep us out of trouble by helping us select good candidates, even for the treacherous markets of today.

Following the strategies described above, I have entered PCCRC for JNJ and AMGN, even in the mist of the worst week ever in Wall Street. However, even if there were not such rare cases, there is one more search condition that I rarely used. I call it the IV skew strategy.

Provided that there is a large difference between the front month and the back month volatility, we can tolerate a slightly higher volatility than we would normally use. One can use the ThinkorSwim platform or Optionetics platinum, to locate stocks with a high volatility skew. Take for example RTN:



The difference between December and May options exceeds 20%. This is particularly unusual considering that the company has just reported earnings. Perhaps the election has something to do with this, but it is quite clear that this imbalance is going to have to resolve. I have to be more vigilant with this trade because once the volatility skew resolves either with an increase of the IV of the back month options, or a decline in the front month IV, I have consider exiting the trade.

Note also that I have bought OTM calls. Given the current market conditions this is not a bad idea. By doing it this way, I give my trade a more than unusual bearish bias, but if the market decides to bounce strongly once and for all, I’d have Gamma on my side.

The flexibility of this form of trading comes at a price. The trader must have a clear understanding of the Greeks. The risk in this strategy is quite tame, but only at the right time. I have been trading the PCCRC almost exclusively since 2005, and since then my returns have far exceeded my expectations. Please take advantage of it too, and if you succeed, as I am positive you will if you put enough effort into it, Please Pay It Forward!

You’ll be surprised and delighted of the calm confidence that comes from trading this way.