Buy Cheap Volatility – Sell Expensive Volatility

[00:00:00.07] - Speaker 1
Sam.

[00:00:43.02] - Speaker 2
Hi everyone. Welcome back. And we are back here at our Volatility Corner with Ryan. And last time we were here, Ryan, it was two weeks ago and the world was a completely different place than what we are today. So it's going to be very interesting to see what you got for us today. So thank you for being here.

[00:01:02.21] - Speaker 1
Yeah, thanks again for having me. So once again, welcome to Volatility Corner. This is where we, you know, talk about what's been going on in the world of implied volatility, what it's telling us about kind of outlook for, you know, forward market movements. And we try to think about how we would structure some trades to take advantage of that and where we're getting paid or we can get cheap, you know, exposure to big moves. So again, to just jump, you know, first thing, just high level overview. So where are we in the world? I always like to start with my term structure, you know. So the term structure of volatility is, you know, on SPX to me is the kind of first place to look when I want to get a sense of what's going on in the world, in the markets. And when we did this a couple weeks ago, I mean, things were bananas. We said it was a great time to sell options, particularly short, dated options. That's really worked out well if you were able to take advantage of that. Markets have not realized nearly as much volatility as one might expect over the last, you know, over the last few weeks.

[00:02:13.19] - Speaker 1
And implied volumes and short term, implied volatility has really come off quite a bit. That being said though, you know what, I think this is a weird time. And I'll be honest with you, these are tricky times as a trader because we always want to look for extremes. We always have this idea of what do we think fair value is, what's normal value. And so when we're in the middle of the range like this, we got to be really careful, you know, I know part of the fun of this is that we, we talk about trade ideas every week. But right now I'd be really careful because, you know, we're, when we're in these middle zones like we are today, you know, you can see this, the current term structure, I mean, ball's a lot lower than it has been. So if you keep selling options the way you have been, you got to realize there's a big chance we'll get another spike involved and those options will be marked against you. But at the same time it's, we're not nearly cheap enough to be Buying options yet. So any strategy, I mean, you know, what was it just a month ago?

[00:03:08.21] - Speaker 1
I think we were trading like 15, 14, 13, implied volatility and we're still everything. Even, even far out the curve is 20. So you know, the first thing to say is we've got to be careful with all our trading right now. This is, you know, actual realized volatility is low, but, but forward implied volatility is still relatively strong. You know, long term implied volume above 20 is still pretty healthy. So the market's saying we think things could get crazy at some point. They're putting a nice implied volume premium into that market. But at the same time we know it can go a lot higher really fast. So how do we take advantage of that? We're going to talk through a couple different trades today. I've highlighted a few. As, as I've said, you always want to have these things line up with your view. You don't want to just express a trade based on, you know, like, okay, I see this volatility is telling me that, so I'll do that. If you don't know anything about the underlying or you don't have a view on the underlying, you'd really like to see your fundamental view married with your options view or at least they don't conflict.

[00:04:17.15] - Speaker 1
So we'll talk about a couple of basic options trades, then a few advanced options trades. But whenever we design a trade strategy, we always want to start with this concept of what's rich and what's expensive. Right. So let's first do that. So let's look at these different charts that we have and think about what's rich and what's expensive. So when I'm looking at this chart, what looks rich to me, you know, I'd say that short dated volume is still, you know, it's not cheap, but it's certainly not expensive either. I mean this is right in line with where we were, you know, a month ago. I just don't really see a huge, you know, huge change in here. And so I'd be pretty comfortable or sorry, I would, you know, I don't think you're getting paid a premium right now to play in the short dated options market. That being said, if that's where you play, it's also not exactly, it's not cheap either. So you know, if you feel like you have a good strategy, you know, you probably carry on. But it's pretty neutral right there. What does look expensive to me, like I said, is this long term fall.

[00:05:26.26] - Speaker 1
Now maybe it's not expensive in absolute terms. We know it can jump another 5, 10% if we, you know, if things start getting crazy again with this kind of trade war. But, but relative to most other periods, I'd say if you can get long term volatility above 20%, that's probably the more expensive thing. That's probably the closest thing to start anchoring our trades around. So Great. So that's, that tells me that right now I'd probably, if I had to pick a direction I'd probably be selling volatility. And from selling volatility I want it to be longer dated volatility because I feel like the short dated volatility could still come off a lot, but the long dated volatility of the term structure is still pretty strong, pretty firm. So that's what I'm going to kind of start with. That's my starting thesis and we'll check the cues as well and you're going to see a very similar, you're going to see a very similar structure. You know, same concept here. Most the time the things that we look at will apply. I'm not sure if that's a, that looks to me like a bad data dip there.

[00:06:32.11] - Speaker 1
Could be based on some earnings, but you know, same concept for cubes except you know, long term volume is even stronger relative to where we've been. So I might, I did these examples on SPY example options on spy, but I may want to turn around and do these, these same trades that we're about to talk about on, on the queues. I think those could, you could make an even more compelling case for that. Great. So then, so we know that that long dated volume is, is fairly expensive. So you know, if we're going to be selling something that's kind of where we want to probably anchor our sales. But we also agree that volume's not, you know, it's not terribly high either. So we probably want to be cautious about just outright selling volatility in this market and say it's not a slam dunk. You know, again, these things aren't, you know, hard and fast rules. But in the back of my mind, anytime volume gets into the low to mid teens, you want to think about strategies that are buying volume or at least neutral to volatility. Whereas once wall gets into the 20s, you can start to think about being a seller, you still probably want to have some tail protection.

[00:07:43.17] - Speaker 1
Once you get volume into the 30s, 40s, 50s, you know, then you can start to think about like, all right, I want to sell Volatility, Like I think the markets put enough premium in here that it makes sense. And this is all for indices, you know, I would, I would adjust all that you need. That's probably using spx, you know, for Q's, you probably need to bump all those levels a few percentage points higher. And if you're looking at a single stock, you'll need to jump, you'll need to scale that accordingly. Okay, so then where is, where is cheap if we want to buy options? Well, again, like I said, we're really stuck like right in the middle of this range. The volatility smile has barely moved over the last month. With the one caveat being that these calls have started getting cheap again, especially relative to the puts. I mean, you know, they're not, they're not super cheap. But if I was going to buy something, I'd be looking to buy calls. These kind of, you know, I'm not personally super bullish, but if I was looking at that level right around 6,000, just above 6,000, that's where the call starts to get relatively cheap.

[00:08:49.14] - Speaker 1
So like call it the 610, 620 call on spy and you're suddenly starting to get much lower implied volatility out there. Okay, so now we have the kind of basic fundamental premise and we can check cues as well. I believe we'll see the exact same thing. Look how much cheap the puts have stayed bid. Puts haven't really come off that much. And yet, and yet the calls really have, the calls have gotten much cheaper, much faster. So again, if we want to buy something, we want to locate it in that calling. So that gives us the basic premise for, you know, for a trade. So then let's think about it. So you know, one thing that I've seen a lot of professional traders, one of my old mentors used to do very successfully was selling long dated options to buy to finance kind of short dated option purchases, particularly on, you know, when we have a view kind of picking our spots. And so one thing that I like here, you know, so it's a very simple version of that. Let's just talk a very basic option trade would just be a covered call. Right now I still think you're getting, you know, so if you're totally neutral on the market, you're not sure what to do.

[00:10:08.17] - Speaker 1
You've got stocks, you're nervous. We just rallied. What have we just rallied? You know, about 60 points on spy. You know, S P's moved from, you know, close to 5,000 all the way up to 5,600. And you're thinking, all right, it's been a nice rally. I'm a little bit concerned, you know, I still think you're getting paid a nice premium, you know, to, to do the long term sell a call. I'm looking at the right now the end of July, 565 call. I believe you're collecting about 20 bucks. So pretty healthy premium. You know that kind of implied annualized rate of return on that is, let's see here, we're going out, so we've got three months in there to kind of multiply that by four. You're getting kind of a 14 annualized rate of return, give or take if you're doing covered call strategy right now. So I'd say that's, that's still pretty healthy, you know, if you can collect a 14 rate of return. Now obviously that will vary depending on where the markets actually go, but you know, that's pretty healthy strategy right there. So if I'm neutral, I'd just be looking at a very simple covered call here.

[00:11:29.20] - Speaker 1
See if I can basically lock in some of the gains that we've had from this recent rally and you know, benefit from that longer term volatility. Again, we want to be going out a couple of months, you know, at least, at least 30, 40 days based on this term structure here. You know, we want to be at least out on this part of the curve where it looks still relatively expensive to lock in those option sales. So what if we're bullish? How do we take advantage of this? So the trade that I like right now is to really take advantage of this term structure. If I'm a bull, I'd be looking at how cheap these short dated options have gotten on the kind of 15 to 20 day time scale. 15 to 20. I mean this is basically pricing in that, you know, particularly like look right around here actually around the 10 day period, around 10 days. I mean it's basically saying hey, like we're back to a boring normal world. Like, you know, all the crazy stuff is over. I don't know if that's because the markets, market seems to be implying that, you know, Vol's going to be elevated as long as kind of Trump is, you know, having these battles.

[00:12:48.11] - Speaker 1
But I think the market's frankly just tired out. You know, it's hard to sustain very high realized volatility. And so what we've seen is frankly the market just hasn't been able to keep up with these, you know, 60 level vixes and you know, 60 implied volatilities. And so I think this is frankly just the market kind of getting tuckered out. And as it tires out, I think that creates opportunities for traders. And so again, you can get in this kind of 10, 10 to 20 day window, you can get pretty cheap options. Not cheap in absolute terms. I mean, I'd still say that these are not exactly cheap. We can see that a month ago they were considerably cheaper. But I'd say they're very cheap compared to the long dated stuff. So what I like here is looking to finance some short dated bets and that's going to be kind of. All the strategies we talk about for today are going to be based on this idea of how do we finance a bet if we have a view, you know, let's finance a bet by selling the expensive thing and buying the cheap thing.

[00:13:53.28] - Speaker 1
So I'm going to start with this premise of selling say a long dated. So, so this is what I like here. So if you're bullish, very basic option trade, you can start by selling along a long call. So the 731, sorry, so. Or put in this case rather. So if you're bullish the market, you want to get some upside exposure. You think, hey, I think that, you know, Trump seems to be caving in to a lot of this pressure. I think there's a decent chance that the Senate or, you know, or just Trump's kind of polling starts to push him towards a negotiation. And I'm concerned about a short term, you know, maybe there's a short term settlement with China, short term negotiation settlement with a few other big countries and that's going to cause a big quick spike in the market higher. Then I'd be looking at something like selling a long dated call and buying a short call. So in this example, we could sell that same call we talked about for 20.3 that, you know, say that or sorry, the same put we talked about. I put this strategy wrong here. I'd sell the long put.

[00:14:58.19] - Speaker 2
Ryan, can you just make the maybe a bit bigger if you can.

[00:15:02.04] - Speaker 1
Oh yeah, of course. Sorry. Is that better?

[00:15:07.15] - Speaker 2
Yeah, perfect.

[00:15:10.02] - Speaker 1
Yeah. So I, I'd start by, you know, selling the put here. So I'd be looking at selling maybe a 560 put through July, collecting a little over 20 bucks probably in premium and then, and then look to reinvest that. So don't get greedy. Right. When we say that volatility is not super high, it's high, it's firm, we'd still rather be sellers than buyers on that kind of 60 to 90 day term. So, well, then let's reinvest some of that in and if we get the direction right, then we can, you know, we could, we can make some real money. So here I'd be looking at buying, you know, say like a 6 13, 590 call. And that's pretty cheap, like four and a half bucks. If you like to play the zero DTE market and you think and you find some cheap stuff there, then I'd say maybe just, you know, you can even play with those. There's a lot of ways you could spin this. You could buy call spreads and then you get even more bites at the apple. And if any of this is not making sense when I'm talking about these kind of bites at the apple or reinvesting the premium, please, you know, as always, post your comments and ask questions.

[00:16:26.23] - Speaker 1
But the basic idea is I wouldn't think of this $20. You know, oftentimes when we sell options, we think, okay, we're going to sell it and sit on it and hope the market doesn't move. I wouldn't, I'm not sure I'd be betting on that right now just because again, like the white volatility is not as high as it's been and there's still a lot going on in the underlying market. So I'd be looking to reinvest some of that premium. So you've got to, I think of it as, hey, I've got about 20 bucks to play with, a little over 20 bucks to play with. I'm going to try to cap my. In this case, I'm bullish, so I want to buy some upside options. I've sold puts. If the market falls, that's fine. I'm still going to get in a way lower entry level. I'm going to be buying into the S and p at like 545. Not a bad entry level. It's pretty close to the low for the last couple of weeks. If the market rallies, I'm not only going to keep that premium, but I've also got a chance to buy in here.

[00:17:27.12] - Speaker 1
So if we spike higher this 590, call that, that I bought for four and a half bucks. Not only do I have a chance if we go to 600, you know, 6, 6, 10, you know, don't make 10 or 20 bucks there, but I've also got the opportunity that maybe we'll just, we'll get a big spike, volume spike again on negotiations in this put premium. We may be able to turn around and Sell that, put that premium, maybe 15 or 20 bucks. If that goes to at the money, you know, if we're trading at 590 in two weeks, you may find that you have a $15 option right there. So you can just turn around and sell it. And suddenly you've locked in on a $30 rally. You've made a $35 or $36 in net premium because you've sold this put, collected 20 bucks and then you picked up another, you know, 10 to $15 on, on this call that you can liquidate. So that's a good way to get some leverage, some pretty cheap leverage, exposure to the upside. And if this call expires, worthless, I mean, you'll get a chance to play the same game again, right?

[00:18:34.03] - Speaker 1
You want to, you can kind of reload and trade another one, buy another call. At that point they'll be short dated. Or you could just sell out. Or if your view has changed, you can just sell out of this 560 put. It should still have pretty good value. And the reason for that is as we've kind of talked about, these short dated options are still like still holding their value. So this is one of the nice things that I mentioned two weeks ago that I think is worth always repeating. You know, options tend to hold their value. So it's something to bear in mind or sorry, we would need to buy that one back. But what I meant to say is that this is relatively cheap right here to buy back. So as long as it stays cheap, we can buy back in this window. We can probably get it bought back pretty cheap before a few changes. Okay, so then last one. So if we're just outright bearish, so you know, if you're bullish, I'd be selling the long dated put at the money put and then I'd be looking to buy some calls, call spreads.

[00:19:43.03] - Speaker 1
You could go 0dte 10 to 15 days anywhere to take advantage of the fact that this is, you know, that short dated options are relatively cheap, at least compared to where we were. If you're, if you're neutral, I'd be looking at covered calls. I'd be looking, you know, say take your natural long position in SPY and try to lock in some profits from the recent rally and take advantage of that long term premium. And if you're bearish, maybe just sell the call outright. I mean that'd be the simplest way to just take advantage of that, right? You're thinking, all right, well even if I'm wrong, we go to 585, which would be starting to get up back up there near the highs. You're still, you know, inside your break. Even if we decline quite a bit, you know, you locked in your 20 bucks and you may get another buying opportunity if you turn bullish again. So then let's get to the advanced options trades. So how would probably a more professional trader take advantage advantage of, of some of these things? I'll start to think about some more complex stuff and we'll introduce the concept of delta hedging for those who aren't familiar with it.

[00:20:55.22] - Speaker 1
So, you know, same concept here. Now let's say that I'm bullish but you know, I want to finance it. I'm probably going to look at doing a long dated straddle to sell volatility. So as we discussed the, you know, the long dated vault, still fairly expensive. This time instead of just say selling a call or selling a put, based on my view, I'd sell the straddle. So selling the outright straddle, turns out right now we can pick up about 35 and a half dollars. So 35 and a half bucks. All right, so we're going to start with the neutral one actually just to make that a little clearer. So right now I'm looking on spy the 613. So you know, 45 day straddle is worth about 35, a little over $35 in premium. So you know this, the simple trade here is to just outright sell the straddle. For people who aren't familiar with with straddles, straddle payoff diagram. So the concept of a straddle is basically that we want to, you know, your payoff looks like this upside down or this, you know, this triangle. So the basic idea is as long we're short volatility, so as long as the market stays inside this range, we make money.

[00:22:46.29] - Speaker 1
So we've collected in this case 35 bucks. So if the S P settles anywhere between 525 and 595, then we're gonna make money, right? So that's the basic concept of the straddle. And as professional options traders, we actually take that to another level. Second, pull up our professional options traders, we take that to another level. You know, we would actually delta hedge this. So a quick reminder of what's delta. So delta, the simplest way to think of it is, is to think of that as the probability that the option gets exercised. So an at the money option, let's just say that you sell the, you know, 562 call right now against spy that's going to be a roughly 50% delta option. And what that means is if you want to protect yourself, if you want to just be exposed to implied volatility, not to the underlying market, you know, if you sold the call, you want to protect yourself against the market going up. What do you, you think volatility is high, but you don't want to get caught. If the market rallies, you go buy SPY and you buy about half as much. So if you sold an option on 100 shares, then you'd go buy about 50 shares of SPY to make yourself roughly indifferent to, to the move in spy.

[00:24:32.11] - Speaker 1
So if SPY rallies. Now, the tricky thing about Delta is that it doesn't stay the same. So we just said that, and hopefully that makes sense to everybody, that Delta, you know, will be about 50%. If you're at the money, you figure it's about as, as likely to be in the money as it is out of the money. So then the next question is, you know, how would I kind of. So, so what's going to happen? So if it's 50% at the money, what happens if the market goes, you know, way up? Right. So let's say that we're at 562. We saw the 562 call, and market goes to 590 or 600. Well, your delta's going to start to get pretty high, 90%, 95%. And what that's saying is you're expecting that option to get exercised. At that point, you know that that call is going to turn into spy. So at that point, you're saying it's 85, 90, 95% chance of turning into the underlying. So if you want to hedge yourself, if you want to protect yourself, you sell more, or if you sold the call, then you buy more. In this case, you need to buy more spy.

[00:25:48.16] - Speaker 1
So that's how we would Delta hedge. So that's just a quick refresher. We've, we've posted a class before. Maybe Fabio can share a link later with folks of some of the classes where we talked about Delta hedging. I saw some questions about there on how to get started. We have a basic intro class on, you know, that we've done YouTube and we may repeat that soon, where we talk about, you know, just what are options, how do we use options to think about markets and how do we think about, you know, basic things like the Delta of an option. So anyway, so I would probably, from an advanced option perspective, I would look to Delta Hedge, my short volatility play My short straddle and then I'd start to think about, you know, and then if I have a view I'd look to start buying stuff. And that's kind of what we've been discussing this, that's been the theme, right. We agreed that you know, that this fall is still pretty high, short dated stuff, relatively cheaper and the calls are particularly cheap. Right. So the call wing quite cheap at least compared to where we were recently in recent history.

[00:26:59.13] - Speaker 1
And again that was exacerbated for the queues. So you know, once I've sold my straddle, same deal as we kind of talked about with our vanilla, our, our you know, simple basic option strategies, what are we going to buy back? So the most neutral one, you know, often what we do is we buy a strangle here. So if you're short, so professional options traders, we call this being short the belly along the wings. So I would look to sell the, at the money straddle and then buy some cheap wings. And by wings what I mean is the out of the money stuff. So when we're looking at the smile, well, you know, if this is at the money right here, if market's trading around 560, we talk about the wings, we're talking about buying things out here. So we're talking about buying stuff that's low likelihood, low probability in this case also a low delta. So we want to bet on, you know, we want to bet on a big move in the short dated options that are cheaper. So that would be kind of my, my start. Like as a professional trader. I'd say like I want to be short, short the belly.

[00:28:12.27] - Speaker 1
I'm going to look to buy wings selectively as I form a view. So what happens if I turn bullish? Pretty straightforward again I'm going to be short the straddle. I'm going to look to buy calls. You know, we can buy cheap calls. There's a lot of cheap calls to be had for a buck, a buck 50, especially if we're looking at short dated calls. You know, I think you could get like a 590 call that's fairly short dated for you know, a dollar on spy. And so that gives you, you know, if you think that there's a good chance of a negotiate, negotiated settlement and getting a 6 or 7% rally, or maybe not even 6 or 7%, maybe a 5% rally, 4% rally in a day, then you know that'd be the play. You'll get a lot of leverage out of that. You can even buy A handful of those, you can buy 10 or 15 of those. And if we get the play, you know, maybe we don't end up at 600, but you might be able to turn on some of Those calls for five bucks that you bought for 50 points kind of thing, you know, the one that I picked.

[00:29:20.14] - Speaker 1
And then let's look at the other side. So if we're short that same straddle, we've collected about $34 in premium, we could look at buying puts. But as we discussed, you know, the puts are, as we've discussed on multiple calls, puts are always really expensive when we look at the stock market, like when we look at the overall like index. And again, the reason for that, for those who are new to this, is implied volatility tells us about a few things. One, what the market expects, but also what the market's afraid of. And so what this is telling us is that, you know, implied volatility right now right around here is around 20 ish percent. And if we rally times will, that means that a lot of this pressure has been relieved. People are less concerned about, about the Trump trade wars. That means a lot of the uncertainty has been resolved. So if we get back kind of towards the highs above 600 on Spy, then we'll expect volatility to return to more normal levels, you know, you know, eight, call it 16, 17, 18%. And then. But if things fall again, if things start tanking and we start pushing debt back down to 500, that, that probably or lower.

[00:30:38.11] - Speaker 1
What that means is that we're probably in a crisis. It probably means that the trade war, these concerns of economic recession are starting to show up. People are starting to worry about how that's going to spill over into broader markets and you're likely to see some sort of panic. Markets tend to move in bigger, you know, bigger daily chunks and also people pay even more for protection because they're afraid. And so we see this big premium on the puts. Okay, so we've talked about that quite a few times about how puts are generally expensive when we're looking at the indices. So what do we do with that? If I'm looking to buy wings, I. E. Like kind of, you know, out of the money options, betting on a big move one way or another, instead of buying the puts, which can get pretty expensive, I'd look at a nice put spread. So the put spread that I picked out was the 515, 545, 535 foot spread. So that's a, that's a nice one. You know, I was pretty, pretty intrigued by that. So that's a, that's a bet that in the next, you know, two weeks, a little over two weeks that we'll get back down to 535.

[00:31:48.25] - Speaker 1
Not a huge move, you know, not a huge move given where we've been. And you're only paying about a dollar fifty for that. So you have the opportunity to make ten bucks on the put spread. Quick reminder for people who haven't traded put spread. So the put spread payoff diagram for everybody who's seen their hockey sticks. So usually if you are, are short of put, then you would expect to just make money as the market, sorry, if you're long a put, you would expect to make money as the market declines. If you're longer put spread, then you start making money, making money, making money and then it taps out. So the maximum amount that you can make is the width of the put spread. So in this case we're looking at a ten dollar wide put spread, the 545, 535 put spread. So what we're saying is we'd be long the 545 put. We'd be short 535 put. So we'd be able to make money from 545 down to 535 and then we would stop accumulating. So we can make 10 bucks on the put spread. We're paying a buck 50 for that. So these are nice because you could do some implied, implied probabilities if you think that there's a better than, so a buck fifty for the chance to make ten bucks.

[00:33:15.20] - Speaker 1
So you know, we're saying it's about a fifteen chance is what the market's telling you. There's about a 15 chance that by May 15 that we end up below at or below 535 in spy. So if you think we've got a higher shot of that happening, then that's probably what I would do. And that way. And the reason that this strategy works nicely is when you do a put spread, you know, going back to these put that we talked about, you're both buying a put and selling a lower put. So you're. So yes, you're buying expensive implied volatility, but you're also selling even more expensive implied volatility. So like for, for the hedge fund that I manage, we're almost always buying put spreads as opposed to outright puts when we want to hedge our exposure. And again, it's just taking advantage of the fact that people are willing to pay this Big premium for insurance. We don't just outright sell that, mind you, because things can get pretty crazy and we're trying to do risk management but, but we can, we can really cheapen up any puts that we buy. So almost anytime I'm, I'm a net buyer of options, particularly on the put side, I want it to be structured as a put spread.

[00:34:27.29] - Speaker 1
I can just take advantage of that. And again you're, you saw that in the example that I just posted of how I think that's awfully cheap, 15% chance because you know, in my view, again, you know, everyone's got to form their own view. I'm not making recommendations on the economy and that's not what my fund does. But I've got to think that if, if we start to see more impact of the trade war starting to filter through into the economy, we just saw GDP contracted. You know, I've got to think that if we do start going down, we're going to go down at least 10 bucks. Whereas if, you know, things stay steady, like, you know, maybe we, maybe we stay steady and stick here, maybe, maybe Trump continues to cave and we, and we continue grinding higher, maybe we sell off. But I gotta think there's at least a 1/3 chance that we're going to be at 5,35 here in the next few weeks. Again, just my view, but you know, I'd say if the market's only pricing in 15 chance, that sounds like it's certainly not expensive. We'll leave it at that. And remember, we're talking about selling a straddle.

[00:35:36.08] - Speaker 1
So we're talking about, you know, selling a 560 straddle for 35 and a half dollars. So, so that's, so there's a few different things. So if we sit, so let's walk through how that could work out for us in a couple of scenarios. So if we sell the 560 straddle for 35 and a half bucks and the market ends up at, you know, 525, if we just sold the straddle, well, we're pretty much indifferent. You know, we've more or less lost all of our premium. But if we also bought this put spread for a buck fifty, then we just made eight and a half dollars net. So you know, we've so suddenly our, our effective like option trading P L is now going to be like, you know, call it. If we made eight and a half, well we made ten on this. So we're going to make about 44 bucks. There's in option Premium. So, so we can actually now we can write out a sell off all the way down to 515. So, so if your view is somewhat neutral, we're selling the straddle, but I'd like to protect against a bigger sell off.

[00:36:54.27] - Speaker 1
Buy this real cheap, put spread a buck 50, you're not showing out very much at all and suddenly you're protected down all the way to 515. So if we sit here, you, you pick up 34 bucks instead of 35.50. If we grind lower again, you'll make somewhere in between. And if we end up a lot lower, you know, you're still covered all the way down to 515. You know, once we get below that, you lose a little bit of money. But you know, if implied volatility is picked up as it should, then you'll have another chance to sell options and collect a lot more proof premium. So it's a, you know, an advanced options trade. I think this is the one that I probably like the most right now would be buying cheap put spreads and financing them with selling long dated straddles. So we got a little bit more advanced today. These are probably a little bit more advanced options trades than we normally talk about. And the reason for that is again what I said at the beginning of this is we're stuck in no man's land, right? You know, we're looking at the put skew here.

[00:38:02.02] - Speaker 1
Just a quick reminder of this chart that shows the put volatility compared to the call volatility. And we're pretty much stuck in the middle. And same thing looking at our term structure. We're way below where we were five days ago. We're way above where we were a month ago. Stuck in the middle. So again, traders kind of hate this. Traders like extremes. We like to see things get really rich, really cheap. That's when we can swing in. When implied volatility gets really low, that's when we want to swoop in and buy options and start like forming a view and making a bet. Or we can put on a flat price trade and buy an option to protect ourselves. So let's say we're bullish something, we can buy it and buy a put down below to protect ourselves. Or if implied volatility is really high, we can buy the underlying and sell the call if we're bullish, you know, just to give ourselves a little bit of extra protection if we get the trade wrong. So we really like to the trades get simple when volatility is very high or Very low. When it gets trapped in the middle like this, we really have to kind of grind.

[00:39:10.05] - Speaker 1
As an options trader, we have to get into more complicated strategies. And I'm always happy to answer questions that people have about these more complicated strategies or if you want to walk through more details of that. But we have to start to look at things like straddles, strangles, buy the strangle, sell the straddle, you know, the iron condor, we can really go down the rabbit hole here. And I know a few of our, a few of our viewers do like some of these more complex strategies, the butterflies, strangle, stratos, condors, and that's the stuff you have to look at. But the core concept remains. And I'd say no matter what kind of regime, market regime we're in, as a professional trader, find what's rich, find what's cheap, you always start there. You say, where's the richest point on the curve or on the surface? Remember this, when we talk about the volatility surface, we're talking about really the combination of term structure which shows us at the money volatility over time, and the smile which shows us for a given time in the future how relatively cheap or expensive calls versus puts are. So you kind of look at that 3D view and you say, where's cheap, where's expensive?

[00:40:22.11] - Speaker 1
So where's cheap? Today I'd say short dated calls. We see that short dated volatility is not absolute cheap, but again, much cheaper than where it was. And then that short term at the money fall and calls much cheaper than where we were. So relatively speaking, the calls, the short dated call is going to be the relatively cheapest place to play in the pool. What's expensive? Long dated puts. Right. Long dated puts are, you know, they're not the most expensive they've been, but they're, you know, pretty firm given how little we've actually seen in the market moving and, and what it seems like, at least the way things are looking, it looks like we're steadily marching higher. So, you know, again, gun to my head, I would say that short, that long dated puts seem like, you know, at least a little relatively expensive. So that's it. So that's every trade strategy. We start with that premise, what's expensive and what's cheap? And then we start to build around that. So we say, okay, you know, if we think long dated at the money volatility is really relatively expensive, maybe we go sell a straddle there, maybe we go selling at the money put and then we Go say, okay, now what do we buy?

[00:41:37.21] - Speaker 1
And again, when volume's really high, it's easy, you know, sell an option. Sell any option. You know, pick one that fits your view and sell it. When volume's really low, buy an option. It's not rocket science, right? When we get in this middle zone, we have to really think about it. We start to look at relative value. That's what options traders do. We do relative value. Joel asked a good question here. When you take a view, what Dte do you typically, typically look at? You know, great question. It really depends, as I said, kind of looking at, at this. It depends where I think is cheap and rich, right? So I'm always trying to move on to out on the curve. I will tell you, as an options trader, I mostly think about implied volatility and will we realize that level of implied volatility. I also think when I'm selling options, I usually have some idea of annualized return that I want to lock in. So I typically don't play in the kind of very short DTE pool that's a relatively new market. It's a little bit tough to, you know, the historical data is not quite there.

[00:42:46.16] - Speaker 1
So I tend to stay away from that one. But that's more just based on my bias. I've always tended to look more at implied volatility. And so, like, if I'm short, say, a covered call, I like to say, well, I've sort. I've sold one three months out, so I can expect, you know, so 90 DTE, roughly. And so I think I'll get a sell four of those over the course of the year. And so what's my annualized return likely to be? And the reason I like to look at those further ones out is, is because if, let's say, the market moves a whole ton, you know, you may not have the opportunity to sell that call again. Right? So like, if you're selling the zero DTE calls, trying to do a covered call strategy, then the market tanks, falls 7% on a panic like we did not too long ago. Suddenly I don't really want to do my covered call strategy anymore because I, I don't want to be short calls down at 500 on Spy, I was happy to be shorter at 560, 580, 600. I don't really want to be short at 500 because of the concern of a bounce back.

[00:43:48.20] - Speaker 1
So that's, that's a, that's an argument in exchange for going out a little further. Because if you're selling the option, you can wait, lock in a premium, but at the same time, we don't want to go out too far if we have this kind of term structure, right? So like what we talked about was if you have this really steep inversion, I don't want to be selling out here. You know, I probably want to be selling like somewhere in here. So I'd say that options make sense anywhere. For me, anywhere from like 10, 10 days to 90 days are usually the main places I look to express a view. But sometimes we'll buy tail protection out a year. You know, like you can buy a put spread relatively using that trick that I just described of looking at put spreads. I've found that sometimes I can buy one year worth of kind of downside put spread protection for not that much, you know, like 4% of the underlying kind of, you know, for annualized protection. That can basically insulate you against a market move. But more than 15% to the downside. Now I don't just do.

[00:44:58.29] - Speaker 1
I don't just buy that and sit on it, you know, but that's nice if we're selling other options or for long against it. So hopefully that answers your question about like where to play. But always let in terms of zero dte or sorry dte like always think about like what the term structure is telling you. It should tell you where to go and where you want to express your view. So we got about 12 minutes left. You know, please keep the questions coming. But now a quick reminder of. So I love to talk about SPX because I think it, you know, I don't follow as many single stocks and I always, I always hesitate when we talk about single stocks because crazy things can happen with, with single stocks unless you, you really are following that stock. I'll get to that question in just a second. Joel, another good question. So if you're okay, so you know, so when you. I want to talk about now we use the screeners and we'll try to do more of this in a couple weeks here. But I really like the. So now we form an overall market view and we say, all right, I've got this idea.

[00:46:06.23] - Speaker 1
I want to sell long dated at the money volatility I. E. Straddles or calls or puts based on my directional bias. And then I want to opportunistically buy short dated options, short dated calls, short dated puts, depending on what my view is, where I find something cheap or short dated put spreads, depending on where I find something cheap. Well, that works for the spx. But what if you have a view on an underlying market. How do you take these discussions, these volatility corners and translate them into this kind of usable, you know, usable trade ideas. So I mean, I would say the easiest way is to look for markets that exacerbate, you know, that show an extreme version of, of what we just discovered. So you know, for example, I'm going to high IV rank. So if we just. So high implied volatility. So let's say that we just were talking about, all right, it looks like long term volume is pretty expensive and we want to, and we want to sell long term volume ball when we can. Let's go find a stock that has even higher long term volume than it normally does.

[00:47:11.24] - Speaker 1
And it hasn't sold off as much. We saw the cues. Haven't sold off as much. I kind of picked this one. Burlington Stores, you know, so Burlington Stores has extremely elevated volatility right now to 58.68. That's in the 75th percentile of implied volatility. So let's go ahead and take a look at that one. Again, I'm not saying you should go trade on Burl, but this is just an example of how we would think about, think about stuff. So, So this is interesting because, because check this out. So this is a lot like what we just talked about, but even more exacerbate, more extreme than spy. So look how expensive like the 25, 24 day options are and implied volatility terms. And look how cheap the short dated stuff is. What's interesting, I checked on earnings for Burl and they actually don't come until the 29th. So you know, we've got a chance here to, to do a trade like that. Like if you had a view on Burl, you could potentially do one of those trade strategies we just talked about. You could sell like you know, a 23, 24 day call or put or straddle and then buy something pretty cheap short dated.

[00:48:36.02] - Speaker 1
If you had a 10, 10 or 15 day view, I mean you're gonna pay significantly lower implied volatility. You'll still. So I mean I think you, you could put a couple of bets on and still have a chance to win on this. And even if none of your bets hit, you can be out of the trade before, you know, before earnings hit. So to me this is like a really nice example of how we form a thesis. We look at, we look at Spy and, and we think about, all right, we know what we're looking for right now. We know what the general market term Structure is expensive, long dated, fall cheaper short dated where we can, you know, we can make some selective bets. So then we go looking for stocks that have this kind of structure in an exaggerated way. And Burl just popped out to me today again I haven't done any research into Burl. I'm not saying if I would be bullish, bearish or neutral but, but the nice thing here is if you understood the last option strategy. We talked about this idea of selling long dated options at the money and then buying kind of selective calls or puts to benefit short dated then Burl would be a great one if you can form a view.

[00:49:53.05] - Speaker 1
And I'm sure there's hundreds of other stocks right now if we start looking through these where we can find a few more. And a great place to start is with these screeners. So in this case I, I know to go to the volatility screener and look for high IV rank. Why? Because we're looking to sell bonding volatility. So I'm hoping to find something with high implied volatility. We meaning future implied volatility. Who knows, maybe NFV will exhibit that same thing. I, I don't know, I haven't checked it yet. We'll take a look and see if that's a good fit. No, see that's, that's kind of a terrible fit there at least if we wanted to buy here. But maybe we'd want to sell like a 15 day option and buy a, buy a 7 or 8. But my guess is that's an earnings peak for NFV. Check with NFP. Earnings are. When's their earnings date? Yeah, 512. So that's exactly. So there's earnings right there. So I would say stay away from this one. And that's a terrible fit for our strategy because you don't want to sell. If you sell volatility here thinking that you're taking advantage of the term structure, you're really just making a bet on or earnings on whether or not that's going to end up being a non event.

[00:51:12.09] - Speaker 1
So, so that's kind of wraps up for today's look at like where we see stuff again the quick summary is you know like, like you said what we saw, we saw this with Spy, we saw this with QQQ even more exaggerated and with some single stocks like Burl we saw the same phenomenon. Very high long dated volatility, relatively cheap short term volatility. Great time to be sell. Well I shouldn't say great time relative. We're in a Tricky stage as options traders. Keep your sales longer term, but be, but be ready to reinvest some of that premium in short term opportunities because short term volume not that expensive right now. If you have a market view, reinvest some of the premium. Don't get greedy because there's a decent chance we'll get a pop here one way or another and you're not getting paid so much on those long term options that you can just sit there and ride it out. So with the last five minutes, I want to talk just a little bit more about Joel's question, which is a great question. So when you sell an option, how do you think about taking profits?

[00:52:16.26] - Speaker 1
That is not just for options. That is the single biggest question in trading. Right? Like when do I take profits? Because there's always this idea that if you trade, that if you trade. Hold on one second, I'm going to try to pull up a chart for you and see if, and see if this will help. Yeah, so there's always this idea in trading of I'm having a hard time finding the right one, so we'll just have to talk through this. But there's always this idea in trading that you want to let your winners ride a little bit. Right. You don't want to get out when you've got a winner on your hands. Whereas, and then like how tight your are your stop outs. If you, if you read a lot of trading books, a lot of traders are going to say let your winners. A lot of the professionals say let your tr. Your winners ride, get out of your losers, quick cut, cut your losses. You know, I'm not sure how good of advice that is, to be honest with you. It is true that a lot of retail investors hold on to losing trades for a lot longer because they become emotionally invested in those trades.

[00:53:24.15] - Speaker 1
But that being said, there's a lot of long term investors who would tell you the opposite. You want to kind of buy the losers and sell the winners. So I think that comes down more to timing. But, but at the end of the day, at the end of the day though, I'd say there's two things that come into it for all trades, not just options. It comes into, when you do a trade, you should always have us like how much are you willing to lose and how much are you willing to make on that trade? And if you say I'm doing this trade, I'm going to risk $5 to make $10 a share. You know, I'm hoping to make $10 a share. I'm risking $5. And you think, well, great, if I'm right, you know, more than 50% of the time, I'm going to on average make five bucks every time I do this trade. But, and here's the big but. But if you take profits at $5 because you get excited, because it's $5 in your favor, and then you get out, you've just shifted the odds against you. Now suddenly you're getting out of a trade.

[00:54:31.04] - Speaker 1
And, and so if your whole concept was, well, you know, I make 10, half the time, I lose five half the time, so I'm on average making five bucks. But if you start taking profits at five bucks, well, half the time you're making five bucks and half the time you're losing five bucks, you've just turned that into a zero expected value trade. I highly encourage anybody who's interested in trading to look at some of the theory of, say, playing poker, sports betting, that kind of thing. Not that you necessarily need to go put a lot of money into that, but understand the theory of expected value. Because when you do a trade, you want it to have a positive expected value, meaning when you adjust for the probabilities and the payoffs, you expect to make money. So it's very important you don't take profit so soon, so early that you've tilted the expected value against you. So now let's finally say for options. So for, for me, I use a very simple rule of thumb for options. And that's to basically say, when it becomes a teeny, I want to be out of it. There's a few different ways to measure if something's a teeny.

[00:55:41.25] - Speaker 1
You can look at the absolute premium, but usually it's based on delta. So if I sell an option that's like 50% delta, 40% delta, and it ends up being like less than 3 or 4 or 5% delta, I'm out. And the reason is at that point, we call it a lottery ticket. It's got like a 1 in 100 chance of hitting. But the amount of premium that you're gonna earn for that is fixed, right? So like, if you sell a bunch of calls and the market falls and time goes by and you're getting close to expiry, and you're like, when do I buy these calls back? You don't wanna buy them back too soon, right? Because as we just discussed, well, then if you had some implied rate of return in your strategy, and you always buy back the calls before they expire, you're not gonna, you, you're not gonna make as much. But the flip side is, what you don't want to be short is lottery tickets. You don't want to be short calls that could loot, you know, turn around and end up in your face just trying to pick up pennies in front of a steamroller.

[00:56:46.08] - Speaker 1
So, you know, again, it depends on the individual market you're trading. I'll talk about SPY in absolute terms, but delta is the best way to do this as an option trader. So if delta of the option gets below like five, I'm gonna buy it back. And so I don't worry about the percentage return on the trade. I just say it's a lottery ticket, meaning the likelihood of it, of it coming into play is very low. On spy, for example, like the rule I use with my clients is one, an option that we sell gets below 50 cents a share, we're usually out of it. You know, we're typically selling options that are worth anywhere between three and 15 bucks a share. And if it gets down to about 50 cents or less, we're out. Because, because options values, you know, they approach zero, they decay asymptotically towards zero. And so, you know, you're hanging on, you got to hang on all the way to collect that last 30 or 40, 40 points. That won't go away 30 or 40 cents when you've already made the lion's share. So that's how I do it. I try to think about on like a decay curve, like, have you made most of the decay?

[00:58:02.25] - Speaker 1
And the other thing is you can always roll it, right? So, so last thing before we close up for today, look at rolling those options. So rather than if you have a successful options trade, if you sell an option and 80 or 90% of the premium has decayed away, rather than waiting to get that last little bit. But also you don't want to buy it back and reduce your long term kind of expected returns on that repeating strategy. What about rolling it down? If you sell a call and the market tanks, maybe roll your call a little bit lower. So it goes from a 3 or 4 delta option to a 15 or 20 delta option, and you could increase. So now you're at least getting paid for the risk. So that's the other thing, right? You buy it back when it's a teami or you make sure you're getting compensated appropriately for the risk. We don't. You know, one of the simple things that I hope everybody takes away from this is don't pick up pennies in front of a steamroller. Don't sell options with very low implied volatility because one day it will bite you.

[00:59:03.13] - Speaker 1
Don't leave short, you know, lottery tickets in your portfolio. Buy them back when they're cheap or, or just roll them, roll them so you get more premium. If you had fun selling the premium the first time, like, let's get more of that or roll them out or whatever. So hopefully that answers your question, Joel. It's a long winded answer and we'll be talking about that for, you know, the rest of our, you know, it'll come up again and again as we do these volatility quarters.

[00:59:30.16] - Speaker 2
Yeah, and I think, Ryan, this was awesome. Today was a little bit more advanced than last time, but I think we have a lot of material in the academy as well. So for those who are getting started with option, just create a free account. There's a lot of material that you can go through our academy and we're going to keep doing this, but if you guys want us to talk about anything specific, like any topics that are interest, just send us an email and in two weeks we'll be back again here, same time, same place and again, thank you, Ryan, for your time as ways.

[01:00:04.15] - Speaker 1
Yeah, thanks, Fabio, and thanks all again. Please, please send those emails with subject line Volatility Corner. Ask for things we'd love to, you know, focus on your questions in two weeks, strategies that you've thought about, things like that. And if you have interest in a class to learn more about this, also email us, contact us. We're looking, we're always looking to set up, you know, private, smaller classes for people who want to get caught up on this stuff and help them understand how they can use these things to increase their profitability.

[01:00:37.06] - Speaker 2
Awesome. Thank you, guys. Have a good week.

[01:00:39.11] - Speaker 1
Have a good one.