Q & A- Understanding Options for a Bull & Bear Market Part 7
Q & A- Understanding Options for a Bull & Bear Market (Part 7)
(Q) Is there somewhere on the OIC site that shows you how to look at IV and calculate IV crush?
There is, there’s a historical and implied volatility tool on the OIC website. You have to go to the website, the menu can be expanded on a top left, and then you have to scroll down and you’ll see quotes and calculators. One tool is called the historic and implied volatility calculator. We can put a symbol in, and you can track the actual volatility levels. And then also if you wanted to not track them yourself historically to see crushes the calculators can be helpful to forecast if an options trading at a certain IV level. And in next week after earnings, you think it’s going to be at a different IV level, you can do that analysis by using options calculators. Just changing the parameters of days to expiration and a new implied volatile and forecasting what you think the new option price will be with some level of certainty and some level of uncertainty. But, I think more directly the answer to the question is we have a tool that will provide volatility levels. You can input symbols, and if you have further questions when you get there and you’re playing around with the tool, the investor services team is very in touch with that tool. They use all of the website material frequently, so if you have further questions send them an email and they will help you out.
(Q) Jason wants to know for a three-way, can it work on a shorter timeframe, say two weeks or three weeks expiration? Or is it more of a long-term options play?
It’s a really good question, because I didn’t address it directly. If I were to speak more on my history of using three ways, I was a little longer term using them. I discussed one of the greatest benefits is taking Theta out of the equation. So, and I was not looking too near-term. If I was very bullish long-term and I was willing to accept the massive risk that I was dead wrong. I just gave the market more time to work in my favor and I wasn’t concerned about what Theta might be doing. So, I might be going out, for me, long-term. Three, four, maybe six months; certainly, any of these strategies can be used on any time frame. But generally speaking, I like the question because for me the three-way trade has generally been one that looks out a bit longer. Don’t worry about Theta and give yourself plenty of time to let the stock move in your favor. Of course your market outlook might be short term and if that’s the case, then you might sort of dial it back and do a monthly or something shorter than that. But by and large for me, it’s been longer term options for the three-way.
(Q) John wants to know how does IV crush or expansion affect the three-way?
Another good question. So, if there is an IV crush on the three way, we have to remember they’re sort of a muted effect. You will likely have two long options and one short option and kind of depends where they sit on the curve and what your strike price selection would be. If there’s an overall curve crush, you would expect that the too long options would have a Vega that are greater than the short option and that would work against you. So, all else equal a general answer with that an IV Crush would work against you. However, the effect is muted because you do have a short option in there and depending on your strike selection, that effect could be greater or could be more muted depending on where the strike sits specifically with those put strikes and versus at the money. You know, again, to be more direct I would expect a volatility crush to have a slightly negative effect as you’re punching a trade up. Hopefully your you’re able to check out what is the Vega of this position? Add up the Vegas. Do the arithmetic on the three position. See what the Vega is. I would expect that it would be positive and then you’ll know that that a volatility crush would have a negative effect.
(Q) Antonio is asking do you recommend the three-way when playing flow more specifically should one be more mindful of strike? More specifically should one be more mindful of strike? I think that’s probably more of the meat of the question, is how mindful are you of the strikes you’re playing in a three-way?
Well, you know, this is my interpretation of the three way; I always started with the zero cost entry and I looked at what strikes worked out that way. Of course, you want to get the lowest strike on the call you can, and the tightest strikes on the put side that you can do at zero cost. The emphasis is on taking Theta away and not having a debit, or if you do it but debit is really small so Theta is not a concern. So, I always start by looking at the stocks at a hundred. You know, what call would I buy? Remember the driving force is the bullish outlook. What calls do I want to buy? And what does that cost me? Then I can take a look at the put side and see, if I sell this particular put, what put do I have to buy to get this at breakeven money? And then you start to analyze the trade that way. Sometimes I price these things up and I’m not comfortable I have to sell to high strike of a put or maybe the width is a little bit too wide.
You know the example I gave those 20 strikes wide. It’s not uncommon to see that, so you’d have to tolerate that wider risk, but sometimes it doesn’t work out very well based on the prices and of course every stock has a different skew to it. So, as you’re looking through the strike price, especially with skews that are more steep, you’re buying that lower strike. You may have to price this up start with an even money analysis on the on all three options and then just do your diligence and incorporate your confidence level. Decide do you want to tweak it one way or the other, move your strikes around take on a little more risk? As I said before, when I would go out longer-term with the three ways, it made me more comfortable with the risk that I was wrong.
If the trade was a significant potential loss, but that loss was really if I was, not just wrong but incredibly wrong. Six months from now if this stock that I think is going higher from today for the next year, if It’s 20 percent lower, than that max loss comes into play. And you can’t make light of it but that provided some level of comfort to me to take that big potential loss and that maximum risk. The question of strike selection is really important because it’s going to determine where you’re profitable and whether or not you can get things done at even money, but I would at least start there. I never wanted to do those at a debit and if the strike selection forced me into debits, I was inclined to maybe not take the trade. I wanted even money or credit.
(Q) As for closing a three-way spread, does it make sense to close those individually or all at once?
Depends where the stock is. If you are doing say a bullish three-way, and the stock has rallied significantly in your favor. If you’re a risk-taker, you might just let the puts expire worthless and not do anything with them at all. That was the approach that I usually took if I was right about the trade. It went in my direction, I was only focused on when and how to get out of the calls. What price do I want to get? Assuming you have multiple positions, and when do I start scaling out on the call side? You can even do more options trades and make it more complex and start selling calls up above to bring in premium and obligate yourself to get rid of shares above that strike. So, if you’re looking on the upside, and it’s working in your favor, it’s scaling out at the appropriate level and just focusing on the calls and letting the puts go away.
Same thing if it’s neutral, it’s letting the puts go, letting the calls go and taking my even money trade and moving on. If it’s starting to move against me, when you’re managing a position and you’re trying to exit you’re always re-evaluating. Do I now not think this is going to be bullish? I thought something was going to happen, and now it didn’t happen. I got this three-way and that has a significant amount of risk, managing things as they’re moving against you is a little bit different. The call options tend to disappear rather quickly if it’s moving against you. You probably can’t get much of anything for it. If you’re selling your long call for very little, it’s usually not worth it. Might as well just hold on to it and see if the stock turns around. But exiting the puts is something that just comes down to managing risk. I guess what I’m saying is, in my experience, did not exit the three-way all in one piece almost ever. I was exiting either the calls or the put side without touching the other side.
Thank you for that answer and I think we are out of time for today. Guys, thank you for joining us. Again, Ed, you’re awesome. Thank you for teaching us and for doing this presentation for us today. Other than that, I’ll let you wrap up and we’re good to go. Yeah. Thanks for the invitation as always and I will see you guys next time. Have a good day. Thank you. Bye. Bye.