How to read Term Structure to be Options Buyers

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

[00:00:39.18] - Speaker 2
Hi, everyone. Welcome back to this Volatility Corner session with Ryan. Thank you for being here, Ryan. Nice to have you again.

[00:00:48.05] - Speaker 1
Thank you for having me.

[00:00:49.26] - Speaker 2
And excited to see what we're gonna go over today around volatility. So I'll, I'll, I'll let you introduce yourself and then we, we can start the presentation.

[00:01:01.24] - Speaker 1
Yeah, thanks. Thanks again. Welcome back to Volatility Corner. And I'm Ryan Darnell. I've been in the industry now trading derivatives for 16, 17 years. I used to run the agricultural derivatives trading desk at Deutsche bank before I worked at a hedge fund managing energy and. Energy and agricultural derivatives. I've since founded my own hedge fund and, you know, done various other things, managing exotic. And I managed accounts for some clients, including managing an exotic options portfolio. So I've spent a long time looking at options. And here at Volatility Corner, we like to talk about, you know, different ways we can use the options market to come up with potential options trades, but also just to tell us things about, you know, what's, you know, what's going on in the world, what should we expect, how should it influence our trading? So today is going to be, I mean, we started to talk about this two weeks ago, but, you know, about two weeks ago, we were in what I was kind of calling no man's land. We were stuck in the middle. And as I said, traders, traders really hate that. You know, as a trader, you want to see volatility.

[00:02:14.03] - Speaker 1
You want to see things either making highs or lows, you want to see things that are very rich or very cheap, and particularly from a volatility standpoint. And, you know, two weeks ago, we were right in the middle, like, okay, things look a little better. Seems like the Trump administration could make some deals and some of the chaos that we saw in March and April could reside. But now we're, you know, but, but we weren't sure yet. And now the market's really shifted into full on. It's all better. All the risk is out of the system. You know, we're gonna go look at that. You know, currently VIX is, is down quite a bit. We're not quite at the lows in the, like, 13, 14%, but we're getting darn close. And so I think, you know, the general theme for today is if your main strategies are built around option selling, I'd start to back off or reduce risk at the very least, you know, maybe, maybe just sell a fraction of what you'd normally be selling and wait. So save some dry powder. That's a term you might hear me use a lot. By the way, we talk about that a lot in the trading game, having dry powder.

[00:03:19.20] - Speaker 1
What that means is if you're not doing this today, you should always be doing this. You should think about how much capital am I truly willing to put at risk? And the more confident you are, the more of that capital you want to be putting at risk. And right now I'd say if you have a nice option selling strategy that works for you, you shouldn't be too confident. Maybe on a few single stocks, which, you know, we'll get into later, but you know, certainly in the broader market scheme of things, I would not be confident selling volatility. So I'd be, I'd be de risking and saving it to see if we get another pop here in implied fall. Again, as a reminder, as usual, I love to answer questions. The more questions we get, the better. And we'd love to start to shift these calls to less of me just talking about what we're seeing in markets and, and more kind of answering questions and we can get, you know, a idea or, or like a question of the week that we can kind of really dig into deeper. As you have those questions, even if you don't have them for today, email them or drop them in the comments and we'll try to, you know, prepare to focus on those next week.

[00:04:24.08] - Speaker 1
Without further ado, I'll jump through and start to do my kind of bi weekly look at what we're seeing in volatility markets. So, you know, as I mentioned, things are, are getting awfully cheap. You know, this is the term structure. So this shows us volatility, you know, over, over time, going back a month. And the interesting thing is, I think when we talked two weeks ago, what we saw was even though front end volatility had come down a lot, long term volatility was still quite firm. We used to have this kind of downward sloping shape where the spot was really, really high and it came down. And so one of the things I warned people was, hey, you could sell longer dated volatility. That's a great idea because it's still pretty firm and you can get quite a lot for selling longer dated option values. But be careful selling the short end of the curve. Now it's turned out that it's worked to sell anything, but you can see how much less the short end of the curve has come off. And so the green line being today. And so hopefully you all kind of listened to that and took that advice as you can see the long end of the curve has also come off a lot.

[00:05:38.14] - Speaker 1
So that was a great sale. So, you know, we shifted from the market saying, hey, things are extra crazy right now, but they're going to calm down gradually as we go forward in time to the market saying, well, things aren't that crazy right now. We're in a wait and see mode. But we still think there needs to be a volatility premium for the long run because there's a lot of risk in the system. And now the market's saying, hey, it's resolved. Right? I mean, look like things are hunky dory. The, you know, we can, like, volatility is coming off across the curve again. Could it get lower? Absolutely. We're still about seven falls probably from kind of the really, really low levels that we've seen in the past. I'm skeptical that given everything going on, we're going to get there. I generally don't, you know, spend too much time taking macroeconomic views, but I think it's worth kind of reviewing the fact that while a lot of the Trump trade tariff negotiations are starting to show signs of promise, there's still overall much higher tariff levels. Right. So we're still looking at like 30% on China.

[00:06:44.20] - Speaker 1
Still. Walmart announced this morning that they're going to plan to raise goods prices over the next couple of months. We saw our first kind of GDP contraction. So there are signs of a recession, you know, in my fund for my investors. I've been warning of the risk of a recession. So I would say that the risk is still pretty high in the system. Will it happen? I don't really believe in making calls like that, but we try to think probabilistically and probabilistic standpoint. I'd say the risk of recession is much higher than what's being priced in the market right now because I would say that this is this kind of 20% implied volatility. And I'll try to pull up a VIX chart here as well and look at it historically, but, you know, historic, like we're getting pretty close. You know, here's when we look at the VIX chart here over the last five years, you can see that while we're not quite at the low levels that we kind of saw when we got down to like 13, 14, I mean, you know, we're basically below any sort of stressful level that we've seen over the last five years.

[00:07:54.10] - Speaker 1
And so I just, you know, again, I think, I think we got to be really careful about selling options right now. Okay, so what do we, so what do we do if we're worried about selling options? Well, the obvious answer is, I guess, buy options. But buying options tends to be a little trickier than selling options. You know, we have, you know, I would say most traders in my experience have a bias. You tend to see, but we have a, we always have a joke. We say, you don't want to be a one armed trader. And so, and what I mean by that is you don't, it's always tricky as a trader. Again, I, I like to think of poker as an example. You know, if you're known as a player who always plays aggressively, then people are going to start to call you and guess that you don't have the cards. So sometimes you got to tighten up in a poker game and, and just wait until you have the cards. If you get that reputation of being as aggressive, being bluffer, you have to, you have to wait till you have the cards and then show them, hey, look, I got you beat.

[00:08:53.00] - Speaker 1
You do that a few times and then people start to get scared and then you go back to what we call playing fast. So in poker we talk about changing speeds, playing, playing fast, playing slow. And trading is the same way. Right? Like we can have a general bias towards, hey, we like to sell options and collect premium. But we got to realize sometimes when the market gets cheap, at the very least we're reducing the risk we're taking or we're outright flipping and we're starting to buy fall. And so if you're a volume buyer, you know, hopefully you stopped buying volume when we got up here and volatility got really, really expensive. And hopefully, you know, you've been waiting and starting to scale back in to options purchases as we come off. And now I can think, I think you could start to get pretty confident. You know, one thing we've talked about in my various calls is having a stop levels. And it's always good to kind of have a view, you know, like how much I'm risking on a trade. With options, it's a little trickier. You know, if you say, hey, I'm gonna buy Spy and you know, it's trading about 490 and I'm gonna get out if we go below 485, because I believe in some Bollinger band or, you know, moving average, whatever technical indicator you like.

[00:10:09.00] - Speaker 1
If you were to say that and you might say, okay, here's where I'm going to stop out, I'm risking five bucks, I'M risking ten bucks on my purchase of spy. So same thing with options. We want to have an idea of what we're kind of risking in volume. And I'd say generally, again, it's trickier with an option. Sometimes you're just risking the whole premium of an option. Sometimes if you choose to delta hedge, you're not risking so much. But regardless, I mean I'd say from a pure volatility standpoint, I would say that here we're probably risking about 5 volts if things go badly. But we stand to make, I mean 15 volts, 12 volts if we get another pop here in volatility, more announcements come out. I mean, sure we could make, if we get lucky, we could jump back up to 45 on the Vix. I'm sort of skeptical we're going to get back there anytime soon. That was a, that was a big market convulsion. But we could, I mean if we go into a full recession, we could. And as a trader we. Not always. I mean some traders, again going back to the like poker and gambling reference, you know, some, some traders like to diversify their bets and win a lot of small pots, other tray and, and maybe every now and then a hand goes really against you.

[00:11:33.05] - Speaker 1
And other traders like to risk small bets and every now and then hit a home run. You know, my mentors and a lot of my trading, we would often say like, hey, let's try to find a 2 to 1, 3 to 1 risk reward. The amount that we're risking, we think we could just as easily make two or three times that. And if you're right about the probabilities, you're equally likely to make two or three times what you're risking, then that's a good trade, right? You have a positive expected value on that trade. And so to me, when I look at VIX here, if I'm, if I'm getting on options in general around 18 and a half percent volatility, any sort of consistently buying volume strategy, I'm going to think that, you know, downside I lose maybe five falls. But upside I'm going to make somewhere between, you know, seven to, you know, seven to 30 falls. Let's call it kind of the average scenario where you make money, you make about like 12 to 15 falls. So that's, that's pretty good. That's two to one, two and a half to one risk reward. Maybe even three to one, maybe even five to one if we really hit a home run.

[00:12:44.09] - Speaker 1
And so if we come off even further if we get down into like 16, 15, then I would say that the risk reward of being long fall is, is getting really appealing. So that's again, you know, that's something to keep in mind as we're looking at trade ideas. Okay so we agree that you know, if we're short fall we're going to start to back off and save our powder for a spike. You know. And same thing with, with selling volume. I'd want to see ball at least in the 20 like Vix at the money ball at least in the twenties before I, I ramp up selling again with the caveat that you know, if it's long dated volume is real firm like this again like 23, 24, 25. I think you can continue to sell that because it's hard for the market to sustain that level of volatility every day. But we certainly don't want to be selling short dated there because that's, it's just can get a lot better, we can get a lot more for our money. So let's, you know, let's save it. So in terms of where to buy options, you know, now we got to kind of think about it and this is going to be very dependent on, on you know, on the individual index that we're looking at and the individual, you know, stocks and there's volatility, smile and the tenor.

[00:14:04.21] - Speaker 1
Since what I was saying before going back here, all options are cheap right now or relatively cheap. I generally be looking to buy longer dated options. One of the things that we talked about two weeks ago is that you know, option, you know, the biggest mistake that I see retail traders like kind of, you know, people who are new to options trading make is they think like I don't want to buy options because you know, you always just lose the premium and they often just buy and hold these options to expiry. And that's the reason. Wrong way to do it. Quick reminder about how. One sec, I'm pulling up an image for you all. A quick reminder about how option decay works. So options decay exponentially like this. So so oftentimes when people do buy options, they buy the shortest dated options that they can find. So this is so this is showing time decreasing to expiry, right? So as, so an option starts out with a certain amount of value and then when we get to the end of its life, if it's out of the money, then it's, it's worthless. The biggest mistake I see is people think oh well, you know, the six month option is really expensive.

[00:15:18.24] - Speaker 1
So I don't want to pay this much. I'm going to pay, you know, I'm going to buy a one month option or a one week option. But look at how fast, look at where you are on the curve. That vault, that value is just going to go away. It's going away exponentially, like you're losing that value really fast. Whereas if you buy, you know, an option out here, hold it for 30 days and then sell it, you're going to retain the lion's share of your value. So what I really like here is buying longer dated options. And you know, almost every time that I've had success trading buying options, it's not been by buying short dated options and then realizing an event. It's almost always by buying longer dated options and then selling those same options. When we get a big boost in implied volatility, you know, you could buy a call option, for example, right now, have the market rally, volatility goes up and you still get a sell, you know, and you know, and you end up selling that thing at a big premium even though some time has passed because, you know, you benefit from this.

[00:16:28.13] - Speaker 1
That plus you know the market's gone up. So you know, you get, you're going to make money on that too. So you're going to make money two ways. And the theta or the time decay in your option can be quite small. You know, maybe you've only bled a few percentage points of the option premium and you made way more on the delta, that is exposure to the underlying and you made more on the vega. Exposure to the implied volatility. Quick refresher, if I'm bringing up words that people don't understand and a reminder that you always, you know, a quick reminder here on the Greeks. So vega. So options options prices have three main factors. Time to expiry, how close to the money they are, and implied volatility. And when we think about our risk, we say, hey, as we lose time value, that's our theta. As we increase or decrease implied volatility, that's our vega. And as the market goes up or down, that's our delta. So it shows us how sensitive we are. So I saw some nice call outs for the poker. Awesome. Okay, so Joel, can you, would you buy calendar and spx, can you specify which calendar you're talking about again?

[00:17:45.24] - Speaker 1
I, I think I mentioned this two weeks ago. I'm always a little like rusty on my structures because we tend to trade Greeks over structures. So if you ever have questions about like, you know, different types of Spreads. Well, you know, just, just please clarify the option legs you're describing because we tend to, as I mentioned before, we trade in our book, we, we currently have millions of option legs or hundred hundreds and hundreds of thousands of option legs. And then we, and we just manage the Greeks and make sure that our D Vega, D, you know, D Theta, D Delta are, are the right directions that we want. So that's kind of how we think about it. And again, if you have lots of questions and you think this sounds really cool, but this is all over my head. We are, you know, we do offer, you know, kind of private classes and so let us, you know, let us know if you, if you'd like to get one. Ah, okay, so, so that's great. So we're talking about like a calendar put spread or a calendar call spread. Yeah, that's what I thought you were talking about.

[00:18:47.09] - Speaker 1
So that's a great question. I do like that strategy. I like that strategy more. When I see the big inversion, when I see this big inversion that makes me feel like, you know, I have a good bet that we won't realize in the short run and then I will be able. And so then it's really helping to finance that long. And so normally that, that can be a great strategy. Let me tell you the problem with that. When the term structure is flat. The challenge when the term structure is flat is so when you sell short dated options you have. And it's funny, I was just, I mentor somebody in one of the trading books I helped manage and we were just having this discussion yesterday. This might be a little advanced, but you know, feel free to ask more questions. When you sell short dated options, you have more gamma, more theta. That's. And what that really means is in simple speak is that you're making a bet very much on how much the market's going to move right away. Whereas when you buy long dated options, you're making a bet on really on how much people are going to be willing to pay for options in the future, if that makes sense.

[00:19:54.14] - Speaker 1
And the reason for that is, goes back to that theta curve that I just showed you. Because these options. Oops. Because these options hold their value so well early in their life and lose their value so much later. So you might be wondering why would anybody ever buy short dated options? And the answer is that of course they're much cheaper and they can very quickly convert into money if you delta hedge the option. And again, we don't have time in this call to go into a very detailed example of gamma scalping or Delta hedging. But the idea is if you remember that delta is the probability of an auction ending up in the money and you've got an option that's just a little bit in the money, like let's say that you're looking at like an spy585 call. Well if that's like a nine month call, it's going to be roughly 50 Delta meaning it's like it's a toss up, it's coin toss. It could be in the money, it could be out of the money. But if you say buy that option and it's got an hour till expiry, it's going to be like 95% Delta meaning that it's going to be you know, basically priced in as being at the money.

[00:21:13.00] - Speaker 1
Like it's expect the market, you know, we're expecting you're going to make about five bucks on that 585 call when Spy is trading 590. And so if you gamma scalp then what you get to do is you get to sell, you know, so you'd be getting to sell a few. So you make money basically delta edging. I'll leave it at that. If you buy options, you make money delta hedging. Every time you sell high, you buy low, where it's the opposite if you're short options. And so so anyway, so these short dated options have lots of gamma. The reason being is that they very quickly move from 0 to 100% and so that's a good thing for the option buyer. So now going back to Joel's you know, question or comment about the calendar spread. So here's the issue that you run into. So if you've sold short dated volume here and bought long dated volume and then we get a real quick event like let's say something big comes and you know the like short term SPY has a big move, you could realize a big loss on your option right away and then and then implied.

[00:22:22.27] - Speaker 1
But if the market does this thing like so if the front of the curve rallies more than the back, it may be that the market tells you well you just took a one time hickey like you took a one time loss. And so you know, if that happens you stand to lose a lot more and you may not make as much as you think on the long dated option because sometimes the front of the curve will reflect of this term structure will reflect all the move and effectively saying that it's a temporary shock to the system. So that's just the thing I would Be careful of Joel. That being said, if the curve was flat, so, so I'd be careful of that because the options you're selling when we're cheap. I think it's a great idea. When the volume curve is when volume is generally high, but you think it's going higher and it's inverted and you want to gain exposure to longer dated volatility, then it's a great trade. If you're actually concerned about some major event happening in the short term and the curve is flat, I would, I would stay away from that strategy.

[00:23:24.26] - Speaker 1
But in an ideal world you have a view. That's something I talk about. Every volatility corner is I like to give everybody general strategies, but I don't recommend trades here. I don't say, hey, go out and do this on QQQ or go do this on, you know, on Apple or Tesla. What I want to give you is the basic tools, basic overall market thing themes and then have you go look at the stocks that you know best or the futures or whatever and apply those concepts. And so, so if you have a very specific view, like, hey, I think, you know, if I'm looking at a single stock and earnings are coming out, we saw one two weeks ago and we'll go looking again for screens. If you go out, you know, if you think earnings are coming out in 25 days and you really like to have volatility exposure to that, but the curve is flat, then by all means, like you could, if you don't think anything's going to happen, sell, sell a 15 day option, a 20 day option to finance the 25. Because then you have a very specific view like, hey, the market's not sufficiently pricing in the potential for a big earnings move.

[00:24:29.02] - Speaker 1
And I'm going to have exposure to that and it's going to be very cheap exposure to that. So that was a very long winded answer, Joel, and I hope that was helpful. But so the answer to doing calendar spreads really, really depends on, you know, what the term structure looks like. Because calendar spreads are ultimately a play on the term structure. So if you're selling short dated volume and buying long dated volume, you typically would like to see an inversion or at least a way more inverted curve than normal. I would not want to be doing that into a flat term structure because effectively that's just a bet on the shape of this curve. And as you can see, like, I wouldn't want to bet that this curve gets even shallower. Although it's possible, this is definitely possible that we see the front end of this go to a discount and we can probably, if we go digging, we can probably screen for a few of those that have that. Hopefully that answered your question. So let's, So let's jump on to so where do we buy? So the theme that I'm noticing right now is calls seem to have gotten even cheaper.

[00:25:43.18] - Speaker 1
So you can see the qqq. The QQQ is. Oh, here, one second. And so just, I just want to clarify again, sometimes it takes me a few minutes to process these things. So in the interest of not making this, I'm seeing some good questions coming now. I love this if we don't get to it today because I don't want to kind of freeze where we are and try to give the proper attention to your question. We'll make it a focus for the next volatility corner. So keep the questions coming. If I ignore them. I'm very excited to have questions. This is a little bit more engagement than we've had in the past two weeks. So awesome. And yeah, we'll definitely. And remember to email those questions early if you're looking at things and seeing things in the market. And we'll build a volatility corner around those. Okay, so because I don't want to go digging for the right matrix and make sure I find everything necessarily, but we'll see if we have time. Okay, so real quick, I want to go back to the theme of where to buy stuff because we talked about, you know, I don't see a great place to sell.

[00:26:46.12] - Speaker 1
If you're going to sell something, you need to have a specific view that there's, that there's a high point on the volatility curve or relatively high. So like what we said going back was, you know, looking at spx. We can look at the term structure for spx. You know, if, if you thought that this point was a little too high, you know, maybe you'd sell like and you thought that we were likely to have an event out here like in the kind of 10 to 40 day, I'd buy like 40 to 60 day volume and sell maybe that if you really thought for some reason that we weren't going to realize over the next two weeks. But, but again, generally as a general rule though, like for to doing calendar spreads where you're selling the front, buying the back, I'd want to have term structure look like this. Right now it's downward sloping. So if anything I'd be buying the front, selling the back. And by the way, the most profitable mentor That I had one of the biggest oil options traders in the world. His, his primary strategy was to buy the front and sell the back and basically use that as a way to get cheap gamma.

[00:27:59.22] - Speaker 1
And the reason that that works going back to that decay discussion is that if an option goes way in the money, the short options don't really change nearly as much, you know, so they have a lower delta. So maybe they're 50 Delta and you're at the money and your short dated option is like hundred is like, can go from 0 to 100 delta. So if the, if the cog. So let's think about the example of trading like a 580 calendar call spread on spy. So if we were to, if we bought it when we were at 580, if we bought the front and sold the back, what we'll see and then we go up 10 bucks, we probably expect that the long dated option only goes up by about 5 bucks because it's about 50 delta. But the short dated option is probably going to go from 50 to 100 Delta. So average 75 Delta. So we're gonna probably make about seven and a half bucks. So you're gonna make about two and a half bucks. Yes, that's right. Short vega, long gamma. So if you buy the calendar call spread and then you get a quick rally, you actually get cheap cheaper gamma.

[00:29:14.08] - Speaker 1
So you'd make, so you'd make about two and a half bucks on that call spread. If it works for you and you could lock that in by delta hedging, you could just turn around and then sell. If we go from 580 to 590, you turn around and sell spy at 590 and you've just locked in a two and a half dollar profit. If we then fall back, well, your long dated option you're only going to lose five bucks on or you're going to make five bucks on. And now instead of losing, you know, instead of losing because you delta hedged, you'll print another, you'll print another couple of bucks and so on the sell off. And so yes you can, you can go short vega and long gamma by buying short dated options and selling the back, which is the opposite of the original calendar call spread you sent over. And the basic idea is, you know, when I, I would say when the curve's downward sloping like this, you want to be generally long gamma. And, but you can also weight that. Again, I know we're going into pretty advanced stuff here, but I love, I love to respond to these great questions.

[00:30:24.27] - Speaker 1
If you don't want. So. Yeah, so. So if you don't want to be short Vega, I think where Jules, I see exactly where he's going with this. If VIX is near the lows, how do you prevent yourself from being short Vega? Because then you run the risk that you bought the short dated option, you sold the long dated option, the curve rallies so you. Or so the front end of the curve rallies so you feel great, right? You feel like, hey, I'm so smart. But then the whole curve goes up and you've still got to buy back that long dated option that you're short at the end. That's the Vega component. So your short vega right when we were literally just talking about this yesterday. You can wait trades. If you actually look at your Greeks, if you actually calc your Delta, Vega and Theta for your options portfolio, you could wait that. So if you are concerned that VOL is cheap, what you would do is you would buy a few more short dated options to account for the fact that they have less Vega. So it would be a Vega neutral trade. Or you could even do a fly.

[00:31:25.19] - Speaker 1
You could say buy the 10 day, sell the 40 day by the 80 day, cause that'll have even more Vega. So there's a couple ways you could do that as an options trader. But if you're concerned about exposure to implied volatility because you want to bet on implied volume going up, you can adjust that trade so you can buy the calendar spread either in a ratio or do a calendar fly. But the basic concept is you just want to get a little more Vega into your book so that you're at least neutral and possibly long. So if you're not just outright buying options and you start to do these more complex spreads, that's how I would do that is I would, I would look at my. You know, if you're going to get into more spreads, particularly more than like two legs, I would recommend everybody, you really need to check out our video on, on calculating your Greeks, what they are like. And I said we're overdue. We need to have another follow up discussion about, about what they are and how we track them. Because you really gotta look at your Greeks when you get to that point.

[00:32:29.27] - Speaker 1
It's really difficult to have a smart calendar call spread on if you're thinking about it from a volatility standpoint. It's fine if you're just trading the underlying and you're just betting on timing of price moves like around an earnings move or some sort of report date. But if you're trading it from a volatility standpoint, you really gotta have your greeks so you don't end up expressing a short vega position. So that was a great point, Joel. You absolutely don't wanna get, you don't wanna buy the spread and get short vega. When we just discussed fact that you know Vol is expensive. If this gets to be a really downward sloping like if the market was putting in like 20 in the back but the front was 15, then I'd really like that spread because I would be short, you know, then I'd be short decently high long dated ball. So I wouldn't, I. You could still do it vega neutral but then I wouldn't have implied volume exposure and I'd still be financing my options. Now who knows if we'll get that? We probably don't get that because like I was saying, a lot of the professionals look for that when they see that opportunity to sell long dated vault that's bid that has a premium in it and then use that to finance cheap short dated options.

[00:33:41.20] - Speaker 1
They're gonna, that's the trade you want to do all day. So that's one to be be on the lookout for always because it can really work. Good question here. So I think vortex, I think we actually answered your question about the cell QQ sell the June by the July, we did the opposite of that. So we in our example we just talked about buying the short dated and selling the long dated. So everything would just be the opposite here. So if you sold the short and you get a big move in the and you bought the long dated, it'll be the exact opposite. So if, if the market rallies in the short term, you won't participate as much and you'll lose some money. And so to make that if it's like a hard rally particularly or if you're delta hedging, but you can make it up if implied volatility goes up, you'll still make more on implied vega and that option that you're short could expire pretty quickly so you have a better chance of expiring worthless. But you know, same thing you're. If you do it equal like one for one, then you really need the market to rally in that case because you'd be long vega.

[00:34:59.23] - Speaker 1
So that's the answer to your first question vortex. Again, let me know if there's more if you follow up. Diagonal spreads versus calendar spreads. Great question. As an options trader I always want to try to decompose that into two things. I rarely think about a diagonal spread so for those who don't know, a diagonal spread is both a calendar spread and a vertical spread. So a vertical spread is say we buy the at the money call and sell an out of the money call. We buy a close to the money put and sell an out of the money put or vice versa. We could do the bear count, the bear vertical spread. So we could sell the up the money call and buy the out of the money here, which I've said in the past, if you don't know about those and you sell options, please, please, please learn about those vertical spreads because I highly recommend retail traders, you know, sell a call spread or sell a put spread rather than selling a naked call or put. If it's a covered call or it's a cash secured put, that's a different story. But if you're selling the options, please own tail protection.

[00:36:00.26] - Speaker 1
The reason that I say that is because you'll live to fight another day when a crazy event does happen and you limit the capital you can sell. I'd rather that you sell two call spreads, then sell us, you know, to get the same amount of premium, then sell a single call because every now and then something bananas happens and, and you, you want to live to fight another day, you don't want to lose more capital than you thought was, was feasible. And so that's, you know, my basic advice to you all. So diagonal spreads, so, so that's a vertical spread. We buy a call, we sell an out of the money call, we buy a post on money put a calendar spread, what we just talked about, right? We buy a short dated option, we sell a long dated option. So, so really the right way to think about it, diagonal, which, so it's doing both, right? So maybe we sell an out of the money call and buy in at the expiring, expiring in 20 days and we buy a 40 day at the money call. So that would be an example of a diagonal spread, I don't think.

[00:37:05.20] - Speaker 1
You know, you really just decompose it into two parts because whether or not you make money on this, because you're basically making a bet on both SKU and term structure. So today we've talked almost entirely about term structure. We're about to go to SKU next, so let's pause on that and talk about how a diagonal might look given ours. So if we look at the current term structure and we say, hey, you know, if anything, all else equal, I'd want to be along the whole curve. If I'm not comfortable just getting along the Whole curve and I'm going to finance it. I'd probably aim to buy more short dated, sell more long dated and weight it so that I don't have exposure to implied volatility going up. Because we definitely want to have at least neutral exposure to volatility going up right now because as we discussed it's kind of like a two and a half to one risk reward on volatility. So now let's look at the, look at the SKU and we can start to think about like where there's an opportunity. So when we look at ski right now, unfortunately this is kind of what I was saying.

[00:38:15.12] - Speaker 1
This is, this is in that no man's land that traders don't like. This is pretty boring to me. So you know, puts, puts were pretty expensive. Then the puts got really cheap and now they're like in no man's land here. So I don't see anything great, you know, on the, on the SKU chart. So let's go look at the smile. The smile's behavior has been a little bit weird. We'll look at on SPX and Q's. So the put SKU hasn't moved a whole lot. But what's been, I mean it's. But what has moved a lot is this, this tail for the calls has gotten really cheap, relatively speaking. It's got everything I say is relative. I mean we don't have a lot of historical data here. So you got to go do your own research afterwards. So what I see here is, is that you know, if I am going to buy stuff, I want to be buying calls. And good news, I mean that means an at the money call is about the cheapest place you can get on the curve at the money or slightly out of the money. So if I wanted to be buying Vega, I don't think you have to complicate it with it with a very diagonal spread.

[00:39:34.20] - Speaker 1
I mean the 600 on the spy or something is going to be about as cheap as vault gets. You know, assuming your smile looks like this. So if I'm buying on and if, but if I'm looking to finance it, like if you really do want to sell something, the puts have not come off. So that tells you that there's still so most of the sell off that we've seen in VIX and volume seems to be coming at the money and to the upside. So people are basically saying that. So this is where I love the smile. People are really telling us hey, you know, things have become more asymmetrical. But what they're saying is if we go back down, it's just as bad as we thought before and it could get worse. But if we continue to rally, things are going to be even calmer than we thought before. So I guess that means that the idea is that if we continue to rally, that means we're threading the needle. We've successfully threaded the needle. The Fed has avoided waiting too long. We've avoided the kind of tariff fights causing a bigger economic reverberation. And so if that happens, Vol is priced real low up here.

[00:40:44.23] - Speaker 1
I mean like you're getting 15 balls. So I would say again, if you're looking to buy something, so let's just say now going back to your calendar diagonals question there, vortex. If, if you know, if this curve was shaped a little differently where the middle was higher, like if this green line came curved in there and then curved off down, then I would say, okay, that might be a time to do a diagonal put spread. Because we know that there's cheap volume that we want to buy, but to buy it, it's got to be a little bit out of the money. So the leg we sell, we want to be at the money and the leg we buy, we want to be out. But right now, I don't know that you need to complicate the structure at this point because it's so flat. I would buy Vol wherever I was, you know, comfortable buying it. And I'd probably buy close for the money just because it has a little bit more volatility exposure, more chances to Delta Hedge, and less chance to end up out of the money if we turn up, turn around and give back some of the recent gains.

[00:41:51.20] - Speaker 1
So that would be me. But again, I, I don't have a terribly strong opinion. You could go a little bit higher. But regardless what I want, what I wanted to emphasize here is the call wing is cheap for spx. You know, and when we look at the cues, we see the same, see the same thing. So looking at cues, look again, the calling really come off. You see this. Oh wait, that's spx. Calling is driving this, this sell off. You know, look at that versus a month ago. Look at how everybody was playing for the big rally a month ago and now that's just completely gone. And so again, if I'm gonna buy stuff. So again, if we're just straight buying options, I know for some of our retail traders that's like, like blasphemy because so many people like to sell options and collect premium. And I, and I Generally, I confess, I generally am option seller and premium collector. I like to think of that as kind of earning risk premiums and its own asset class like a bond. So that's generally my bias too. But again, I always try my hardest not to be a one armed trader and that means, you know.

[00:43:16.04] - Speaker 1
Yeah, so, so to me right now I'd probably be, you know, gun in my head, I'd be buying and I'd be looking to buy calls. To me that's just the best, you know, purchase point on the, on the curve in the broader market. So looking at SPX and QQQ and probably long dated, I'd probably buy long dated just to get the most bang for the buck. You can buy short dated, but then that's really only if you have a view that we're going to get an event soon. If you don't have a view, you want to buy the longer dated term structure. Because all else, even though I think that if we get a move, this will move higher, like the front of the curve will move higher, but your options don't have as much vega, you know, meaning that they just don't have as much time. And so people, you know, either, either you get it right or you get it wrong. Like if it's a call and it goes away in the money, great. But if you go, if we sell off and your call goes way out of the money, you're kind of out of luck.

[00:44:10.17] - Speaker 1
Whereas if you buy the longer dated stuff, even if we sell off a little bit, but implied ball goes up, you're, you're protected. So I'd be looking at longer dated calls right now. That's the cheap point on the curve is long dated calls either at the money or slightly out of the money. That's the cheap point. So then, then it's just a question of are you financing that or not. If you're not as comfortable paying premiums or you don't think we're going to get much movement in the next few weeks and you want to kind of finance the trade, then we'd have to figure out what to sell. So the one other kind of, you know, thing that I think we're gonna talk about today is, you know, the belly versus the wings. So I don't know that we've discussed these trades before, but real quickly I want to pull up for you all quick reminder about straddles and strangles. So everyone's, you know, seen the basic call hockey sticks. I hope if you're on this, you know, this is the payoff profile of a call at expiry, you see that you're out the premium.

[00:45:12.02] - Speaker 1
In this case, 200 bucks, no matter what. But if we go above the strike price, in this case 100, you start to make money, right? And then we can build increasingly complicated payoff profiles by bundling options. And the two that I want to focus on today are straddles and strangles. So the straddle, this is. And this is a short straddle. So in this case, you collect premium. And as long as we stay in between the break evens, we make money. If we get outside the break evens, you'll lose money. So, Ryan, why are you showing us a short straddle when you just told us to buy volume? Well, bear with me. You know, what? I like buying here is probably more like a strangle. Strangles tend to be a little bit premium cheaper and give you exposure to the wings. So if. So this is. I bring this trade up for the people who, who, you know, who are asking about calendar spreads, diagonal spreads. My guess is that you're probably. You get a little bit of heartburn. You get a little uncomfortable when I talk about just buying options. You're like, I don't want to be out that much premium.

[00:46:19.09] - Speaker 1
Fine, I hear you. I feel the same. I feel the same, you know, concern. So what do you. So what do we do with that? Well, one classic options trade is to sell the belly by the wings. Sell the belly by the wings. So the way we would do that is we buy the long strangle. So you see that this is just basically a wider version of the straddle. So the market needs to go further to make money, but we spend a lot less premium upfront. And the idea is here is that we really want to be betting on a tail event. We're not betting on lots of movement close to the money. So the classics, the classic trade would be to sell a straddle. Oops. Sell a straddle and buy a strangle. And we would do that in some sort of ratio. And you'll have to calculate your own, you know, based on an individual stock. You'll have to calculate your own kind of ratio and your own, like, tolerance for spending premium and collecting premium. But the basic idea of this trade, if you dig a little deeper and maybe we can walk through an example next week when we have more time, is that, you know, you could.

[00:47:26.24] - Speaker 1
You could proportion this trade so that if we get a really big move up or down, then, you know, we, you know, we can benefit and again a little bit more advanced, a little bit like pro trader thing because of what we just said about, about the smile. I might actually move this a little bit. Where are we trading QQQ right now? 520. So I might actually bias this just a little bit and delta hedge it. I might actually sell my straddle like here and buy my strangle to take advantage of this cheap wing like a 555. Like 550, 540 like if you like if I was again this isn't, this isn't a trade recommendation. This is just kind of like just grabbing a stock and where I think about it but you know I'd probably start, I'd want to make the, the tails that I was buying to the upside be on this cheapest point of the ball surface. So I'd be looking around 550, 540 and I and we'd usually somewhat weight that evenly. So maybe you solve a 500 and then you look at like 450. So 450, 500, 550. You know, 450, 500 strangle versus 500 straddle.

[00:48:58.02] - Speaker 1
That could be another way to finance. That's your advanced options trade for the week to think about for your homework if you want to play around and try to calculate some different prices. The last thing, if we don't have any other questions would be to do a quick walk through of a few single stocks and say, you know, going back to the simpler trade. Now for the, for those of us who aren't wanting to do straddles or strangles and you know, volatility weighted volatility spreads. Again I love the questions, I love the curiosity. Well, let's just talk, you know, very simple. If we agree that generally culture calling and volatility long dating volatility is cheap then what I'd say is you want to go find a single stock and this is going to be repeating every two weeks. Now let's go use the screeners that are available from indoor queue and find you know, a single stock that really emphasizes those characteristics in the market. Right. So in this case we want to buy volume, we want to go find some low implied volume and we want to go find some low implied volume at the wings preferably particularly the calling that kind of exacerbates the market trend.

[00:50:08.03] - Speaker 1
And but again we don't want to do this in a vacuum. We want it to be one that you are familiar with. So I'm going to scroll through these and Just pick one that's extra, you know like kind of an exaggeration of the current market trend but you want to do it based on further like incorporate your trading strategy however you're using call resistance, put support Dax G whatever different things you're using Then we want to blend those on top of and say okay well here's a name that I love so but where I'd start as an options trader is I'd say okay where is IV really low. Where's implied volume? Really low at the 30 day point but realized volume has been decent. I mean these are all really low right. So you know personally. So just looking here, I mean there's not one particular one that's jumping out to me but it looks to me like and I'll confirm I think historical Vol is that is the realized volatility but it looks to me like a bunch of these have been realizing higher than their but we probably want to stay away from like a goofy bond ETF So you know what, let's see what if anything is jumping out to me.

[00:51:32.11] - Speaker 1
I mean here's your like okay, here's one and again I I want to again I can't emphasize this enough. I don't, I don't have a view on most of these single stocks but and so you have to form yourself but you know so ATO is this Atmos Energy Corporation. We've got only 14.8% implied volume even though it's been realizing 22% 2.69 so now we have the chance to go buy a single stock with as low as volatility as the S P so we've got seems like we've got even more margin of safety for those of you value investors out there to play with for buying fall and let's see how its volatility smile compares. The calls aren't as cheap here but with the caveat though that the wings are still really cheap. So if I wanted to be buying wings net net this would still probably be cheaper place to do it and certainly if I was looking at a portfolio this seems like fairly cheap but again for the at the money is the way to go so I wouldn't be doing any sort of straddle strangle strategy here. Don't overthink it, don't over complicate it looks like at the money somewhere in this like 160 to 180 you can get pretty cheap at the money ball 15% so I wouldn't even over complicate that thing.

[00:52:56.05] - Speaker 1
Let's go back and look for one more. We're out of time here. Unless, Fabio, you want me to hit on anything before we wrap up?

[00:53:02.24] - Speaker 2
A couple of minutes left, Ryan, and maybe there's a request to talk about stranglers and straddles. So maybe we can do it in our next session and just look allowed to analyze those. That would be probably a very good topic for next one.

[00:53:18.07] - Speaker 1
Yeah, absolutely. We'll do a deeper dive into how one could do, you know, a full on trade around the belly versus the wings. And when we talk about belly versus the wings, what we're talking about, this is the belly and these are the wings. Think of it like a bird. We think about the volatility. Smile like a bird. So belly wings. And what we're saying is this isn't the right one. We'll go peek around, we'll look at one that's got cheaper wings and high implied volatility. Real quick before we run out of time. Here we go. So let's look for high implied. And this is the great tools that mentor Q has where we can just say, all right, whatever we're looking for today in the market, then we go look for single stocks that really fit that. So I'm going to look for high implied volatility, something where we can find high at the money. And cheap wings. Yeah, absolutely. How to add cheap wings. We will focus on that in two weeks.

[00:54:17.25] - Speaker 2
Sounds good. And guys, if you want us to cover a specific topic, send us an [email protected] and basically just mention what you would like to cover and we, we'll work through it and we'll do it in the next few sessions.

[00:54:34.07] - Speaker 1
Smile curve's not even available. Yeah, we'll find a few that make that make good examples for that over the coming weeks. And are you able to snapshot these questions here, Fabio, before we go so that we can make sure to tackle all those. So, yeah, look forward to talking to you all in two more weeks. I hope this was helpful. Helpful Again, you know, the simple summary. I know sometimes we go into some fairly detailed stuff. I don't want to scare away our people who are new to options. The high level takeaway is if you're selling Vol, be careful or back off, save some powder if you like to buy volume. Now you can really start to dial up the risk. Your risk reward is looking better than ever, you know, and you know, we kind of the cheapest part of the curve is at the money slightly to the call wings and feel free to go out and buy longer dated ball because, you know, that's where you can, it might seem expensive in premium terms, but it's going to hold its value and it's got going to benefit more if volatility does pick up.

[00:55:34.14] - Speaker 1
So that's the, you know, very quick summary. So I hope that's helpful for everybody and we'll see you in two weeks.

[00:55:40.04] - Speaker 2
Thank you, Ryan. Have a great day, guys.

[00:55:41.28] - Speaker 1
Bye. Thanks. Have a good one.