How to use Term Structure to build Calendar Spreads

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

[00:00:40.20] - Speaker 2
Good morning, everyone. We are almost at the end of the week. This week is going to be a short one. So very excited. Welcome back, Ryan, we're gonna spend time with you today to talk about volatility. So very excited about that. Hope you've been well. Thank you for being here.

[00:00:58.19] - Speaker 1
Yeah, thanks for having me back on, Fabio. Welcome back, everyone, to Volatility Corner where we talk through how options traders and equity traders who are new to, you know, new to some of these option models can use the different screeners and use the options markets to get some information and build out a trade and think about it. And as usual, please, you know, please feel free to ask questions. I'd love this to get more interactive and, and talk through, you know, different trade ideas or questions that people have. So first I'll just start, start by going through with a roundup. I hope everyone, all the option traders are still in one piece. It's been a pretty wild market the last couple of weeks. You know, if you look at the spike in QQQ volatility there five days ago or vix, it's been a pretty wild ride. It's a great time for option selling, if you had capital, if you had some dry powder. So, you know, we'll start by just kind of rounding up, looking at spx. We'll start with the, at the money term structure. Term structure, that's a reminder. As a reminder, that's the implied volatility for different option expiries at the money implied volatility for different option entries.

[00:02:20.11] - Speaker 1
And we'll spend a little bit more time today talking about how we can build a trade around this one. So the big thing to note is that with the tariff craziness going on, we've seen a big spike in short, dated volatility, in fact, volatility across the curve. But it is, you know, projected to decay pretty significantly. You know, if we would have been doing this call, you know, four or five days ago, we'd be really excited about this trade. Some of the trades I'm going to talk you through today aren't quite as juicy as they were, but they'll give you, you know, a sense of what to be ready for, particularly if we get another, you know, a couple of big announcements around tariffs and see another spike like this in the Vix and start pushing above 40%. So, you know, talking through the term structure first, you know, I like to look at things, I think I've mentioned this before, we always try to think of traders, always think of fair value. We Try to have this idea in the back of our mind, whether that's based on fundamentals or, you know, averages. If we have information on kind of flow where people are trading things, we always want to think about fair value.

[00:03:32.17] - Speaker 1
So, you know, what is fair value and where should it be? And then are we below or above fair value? Oftentimes when you see spikes like this, you know, when we see volume jump up to 55 or 57 like we saw in the Vix, is that because the market is telling us that they think implied volatility or, sorry, realized volatility over the next 30 days is going to actually be that high? Probably not. Much more likely is that, you know, implied volatility is going up and people are getting stopped out. Right? Like, it's very common that if you have a bunch of market makers or a bunch of specs who are short, implied vault or short implied volatility, and you get a big volatility spike, you know, maybe they were short from, you know, 25, 27, 28, 30, and then when ball started going up, they had to get out of those positions and then that covering pushes it here. So maybe fair value was more like down, you know, 40 or, or 30. And so, so this looks to me like pretty much pure short covering rally. And now you can see that it looks like the market's starting to take it in and say, okay, look, it's not going to be 52% of all.

[00:04:45.02] - Speaker 1
That's not a reasonable expectation for daily moves. And you can actually calculate your break even, by the way. So if you take implied volatility and divided by the square root of trading days, so square root of 252, right. Roughly 15.8, that'll actually tell you how much the market has to move every day to make its break even. So if you take, you know, 56% volume and divide that by about 15.8, give or take, it's gotta move three and a half percent every single day to justify that. Which, that's pretty tough. That's a pretty tough break even to realize. And that break even, if people aren't familiar with that term, that's if you're an a market maker in options and you're delta hedging, so you're buying and selling. If you're long options, you make money. If you're short options, you lose money, then that break even basically tells you how much or how little you want the market to move to cover the premium that you laid out, or your theta bill, as we call it, as Option traders. So yeah, so you can calculate the break even. That's not hard. You don't have to do any advanced options math.

[00:05:50.27] - Speaker 1
You just kind of divide by 15.8 which is the square root of 252 and you can see what, I guess it's 15.875 and you can see what the, you know, daily required move is. So that was probably pretty unrealistic to think that it's going to move 3% a day, every day for, you know, for, for months. I think when we look at the actual daily moves they've been more like, you know, 1 to 2%. And now we're starting to settle in and see this kind of, well, hey look, we think volatility is going to be elevated. This green line is our current situation. So some of this short covering rallies started to move out into the back of the curve as people started to, to build in a more volatile environment. But this short covering rally subsided and now people are saying, all right, well we're going to be a little more volatile. But now our break even's down from you know, 30% to. So now we're down to 1.9% is the daily move that we need. So it's pretty considerably smaller daily, daily move that we need in the S P. So when we see these opportunities, what can we do?

[00:07:05.20] - Speaker 1
How can we take advantage of this? If we have this idea of fair value, how much can the S P actually move? You know, for one thing, if we think well all right, if things get crazy, it's going to move 1 to 2% a day once it starts pricing in three 3 plus percent moves every day, what's it tell us? Good time to sell options. So regardless of what direction we want to be facing, we're getting paid a risk premium at that point to basically help shorts get out of their positions. So that's when we want to be selling. Whereas when we see pretty cheap volatility like out here where nobody was buying it, you know, looking at the 30 day roughly window here five days ago, that's where we want to be buying it. So you know what, today what we'll talk about is a horizontal call spread or a calendar call spread. So the idea of selling options shorter dated to take advantage of this back what we call backwardation and implied volume or an inversion in the curve. So when a curve is upward sloping in trading, we often call that contango or just an upward sloping curve, usually the yield curve, commodity futures curves, you know, S P futures curves are upward sloping or contango occasionally when things get tight, when things get scary, you get this, this downward slope, an inversion or when the Fed say raising interest rates significantly, you get an inversion in the yield curve.

[00:08:37.27] - Speaker 1
And we can call this backwardation or just an inverted curve. So when you see an inverted curve like this, what do you want to do? Well the first thing is you don't want to be buying short dated stuff, that's for sure. But you may not want to be selling it either if you're pretty scared. So one of the things that I would look at is hey, can we sell short dated stuff? Or better yet, can we buy some long dated stuff and finance it by selling short dated stuff? So just an example trade. So I'm going to walk through, you know, three example trades that we could do. My first one is let's say that you're medium term bullish. You know, in this case we're talking spx. If you're medium term bullish but short term bearish, you know, you're worried about what's going on. Then I would look at a calendar call spread. So we could, you know, I just loaded these up a little bit earlier. It looks like we've got just looking at my prices here. So we could buy the 5:30, 43 days till xprey roughly we could buy the 530 spy call or you could do it on spy spx minis xsp.

[00:09:56.28] - Speaker 1
But the 530 or 5300 on the S P call that was about 17.6 for an basically at the money call that's got 43 days again you could turn around and sell the 535. So a 5, 5 bucks higher with for only 11 days and that's getting you 5 bucks. Right? So when you think about that, so you'd be a net payer. So you're buying. So I want to be clear here. We, we'd be selling this call and buying this call. So sell.

[00:10:37.07] - Speaker 2
Oops.

[00:10:38.08] - Speaker 1
Buy. And this is days to expiry premium strike. So you could do this calendar call spread. You'd pay 12 and a half dollars for a call, which is probably not cheap. And I think probably most retail option buyers do not like to buy options because they're thinking hey I'm you know, paying out so much premium. What I find is naturally people don't love to pay premium. They feel like they're giving their money away. So but what can we do here? I mean let's think about this. So this is five bucks for only 11 days. So if the Market just chops here. You know, if you're sort of short term, bearish, you think that these trade wars are going to weigh on things. But you, you want to have upside exposure in another, you know, when this option expires, worthless. If that's, if your call is correct, then you'll get a reload and sell again. And if the market hasn't collapsed from here, and even if it has sold off a little bit, if implied volume is spiked again, you can probably sell another one of these calls for another five bucks in 11 days and so on and so forth.

[00:11:56.29] - Speaker 1
And so if you do that, you know, two, three, four times, you will basically cover, you know, if you, if you're able to do it four times over the next 43 days, you would end up net making money, right? So you'd end up, you know, if you're able to sell a 530 or better call between now and 43 days from now, then you're going to pick up two or three bucks. And what happens if the market rallies? Well, if it just sprints higher, I mean you're going to lock in at least five bucks here. So you're going to make five bucks on the call spread because you're along the 5:30 short, the 535 plus. You know, when this option expires, when this first one expires in 11 days, you're going to have this, this call up, this 530 call left over and it's going to have some extrinsic value. Options tend to decay very quickly. See if I can pull up a chart here. Here's a quick chart for everyone to see. So options decay exponentially, meaning that they, over time so as they, you know, so they can hold their value, hold their value, hold their value.

[00:13:18.07] - Speaker 1
And then at the very end it kind of all tanks. And so if you buy an option again, one of the biggest mistakes that retail traders make is they want to, they don't want to buy these long dated options because they look really expensive, right? Like they want to buy short dated options and, and sell longer dated options because they see all that premium, they see dollar signs in their eyes. But it actually really work professionals think almost the exact opposite. They think, oh, when I sell options I get to collect this part of the curve as the options are declining and losing all their value. And the options that I buy are holding onto their value so I can turn around and resell those. And a lot of the best trades that we used to manage, option we used to manage Price risk for farmers when I was trading corn derivatives book and one of the trades that, that we one of our best trades to protect our farmers risk was the years when we just bought an at the money long dated put at the start of our pricing program. Those were inevitably the best years that we had because it felt like we were shelling out a lot of premium, sometimes 5, 6, 7% of the underlying price of corn.

[00:14:31.00] - Speaker 1
And it almost always turned out that we either rallied a lot and we were able to lock in higher corn prices and get out of those puts or we, we'd sell off pretty quickly, we could sell a lower strike put and recapture all of our premium. And so again, you know, just that's the thing to remember these options that look expensive like this, you know, this $17 that you're paying on the spy that's still going to be worth something. I mean we can in fact we can estimate how much that's going to be worth. We can check out what that's what a 32 day option is worth. I'll give you a quote real quick for that. Looks like the 32 day option on Spy is going to be roughly. We'll just use May as I'll use May 16th as a proxy for that. The May 16th 5:30 call is currently trading around 16 bucks. So markets moved a little bit since I took these numbers. But the point is, look, that's only lost about A$60 of its of its value even you know, maybe, maybe since we've moved a bit since you know, we've rallied a bit since I took these numbers.

[00:15:55.29] - Speaker 1
So maybe, maybe it's more like 14. But you know, the point is you're going to lose just a little bit of the value of this thing and you might have captured all of this on your short. So a very potential, a very likely potential scenario with this trade is if the market goes up to say 545, you know, you, so you'll be out on this 535. So you'll, you'll have a 10 loss. You'll be up 15 on this 5:30 call. So you'll have a 15 gain. But then you'll also have an option that's worth extrinsic value. So besides the intrinsic value extrinsic is, you know, it's option value separate from how in the money it is you're gonna probably pick up another, you know, 12, 13, 14 bucks. So you could easily make 19, 20 on this trade. If, if we get a quick rally and you're right and again that's, that's sort of being financed by the term structure because we can sell short dated options and that's. And those prices, by the way, I pick those using the green curve. So selling something out here and buying something out here, if we had struck a week ago, buying something out here and selling something here, you know, that would have been even juicier.

[00:17:19.08] - Speaker 1
All right, so there could have been a lot of juice in that, in that trade. So again, that's a, that's a nice trade for somebody who's you know, sort of short term, bearish but really, but medium term wants to get long. You know, I, I would definitely look at using again, volatility is high right now, so you don't want to be outright buying a lot of volatility. But you can look at if the term structure is inverted, maybe we can sell some more expensive short dated volume to finance a longer dated position. Any questions about that? Check the. I've got a lot of screens up today. I'm checking the comments here.

[00:17:56.21] - Speaker 2
So far.

[00:17:58.21] - Speaker 1
And please, I'm happy to repeat things. I know sometimes I go fast. I want to both give you all some insight into how a professional options trader thinks. But I'm also here to, you know, to repeat these things and make sure people are learning and understanding. So that was the first trade that I thought of and one of the reasons that I, I mentioned that trade as well is, you know, if we did that we probably want to be doing an at the money call I guess I want to point out. So next thing to check is the volatility smile. So one thing I wanted to flag to everybody is what's interesting here is that when everyone was really scared and panicking, I and what we've seen in every kind of volatility corner discussion that we've had so far, we've seen this expensive put skew. We've talked about that a lot that puts are really expensive in implied volatility terms. You pay more than you would expect based on at the money volatility for a put for an out of the money put. And the reason for that is people want to protect against a crisis.

[00:19:01.23] - Speaker 1
Most people are long the S and P or have a long equity portfolio and so they'd love to be able to hedge against that. Plus when do things sell off? When there's a crisis, when there's fear and so things get more volatile. So for those reasons, both supply and demand and the nature of the correlation of price and volatility, we get this very expensive Put wing. You can see how that put wing was really bid last week and is always bit. But look what's starting to happen here. This is what I think is really interesting. See how this call skew. See how even as the, as the five day, this, the five day ago came back down the, the green line is getting stronger to the call side. So what's going on there? I mean that tells us that the market's starting to get just as worried about the rebound back up as they are as they are about the sell off. So certainly there's still a premium on the sell off, right? We're still quite, quite a bit higher than where we were a month ago and volatility is still quite high in absolute terms.

[00:20:07.25] - Speaker 1
You know, we're, you know, we're looking well north of 20%. But, but you know, the really interesting thing is that again the symmetry is changing a little bit. People are now thinking, hey, wait a minute, we can fall down hard. We can also snap back hard. So starting to see that premium on the call side showing up. And in markets that I've traded historically, like agricultural derivative markets, for example, we see a very steep call skew as people worry about things like shortages. Bwb. Sorry, give me one. Oops. Try to get out of this. Oops. Oh, sorry about that. I got kicked out there for a second. Let me. Here we go. Just checking on BWB for you. Got my first question here. You'll have to, you'll have to bear with me. I, I don't know all the tickers off the top of my head. So if, if you ask questions about particular stocks, you know, please, you know, give a little context. But we can check out BWB together here. So let's. Not see PWB come up.

[00:22:27.15] - Speaker 2
So, yeah, Joy, send us more details of what you want to see.

[00:22:31.23] - Speaker 1
Yeah, send us details of what you want to see, please. And I'll keep going on. I got a question. What's the strategy here? Please clarify if you're talking about SPX or something else. So back to. And by the way, we can also see, we talked about the put bias. You can also see this showing up here, right? So this is the same thing as what we just looked at in the volatility. Smile just represented a different way. So we talked about how the calls were getting more expensive as the puts came off. You can see the same thing here on this three month skew for spx. So look how, you know, as people have gotten more and more scared, the puts have been, have Been rallying and then, and then boom. People suddenly are starting to say, wait a minute, you know, there's the same, same risk of the, you know, of the snapback to the, to the upside. So that's what we see a lot. Let me see here. Broken. I'll check that out. So I see now, so broken wing butterfly. So that's interesting. I will give full disclosure. So all these different strategies that you talk about, butterflies, broken wing butterflies, like iron condors, counter spreads, professional options traders rarely think about those strategies, I'll be honest with you.

[00:23:56.04] - Speaker 1
So we don't tend to use a lot of, you know, shorthand comments for those. And the thing that'll surprise people is right now, I mean, I manage an exotic options portfolio and we have something like 500,000 option positions on, in the book. So, you know, I don't know what you would call that, but it's clearly not, it's clear, not a butterfly or a condor. And so, you know, you'll, I'm happy to talk through these strategies all the time, but usually what we look at is, is, is, is locating the different strikes that we're long or short and trying to locate them on the curve. Right. And so to me, I, I think of it as ultimately a 3D surface, which Fabio mentioned earlier. We're getting excited to roll out. And so, and so, you know, the way that we would do that is we basically say, okay, where, where do we want to be long? Where do we want to be short right now? And so again, five days ago, we definitely wanted to be short, the more expensive part of the curve and long the cheaper part of the curve. And that's worked out very well if we did that right.

[00:25:03.16] - Speaker 1
Like the long dated stuff has appreciated in value, the short dated stuff has gotten cheaper. So we'd be way ahead on that trade. That trade still can make some sense. And so, you know, again, you still probably want to be shorter the more expensive stuff and longer the short dated stuff and longer the long dated stuff. And then similarly, I'd go over here and say the same thing. So I want to be, you know, I want to be right now. I would not want to be long calls. This is about as expensive as, as, as calls have gotten lately. And I don't, you know, that's not normally a very standard, you know, market. We don't have quite enough history here. I'd want to see a five or ten year to say, see how much call skew we've had on spx, but this looks a little expensive to me for calls right now, whereas the puts are actually cheaper. And that's going to walk me to one of my next strategies here that we're going to look through. Yeah, so let's jump into the next strategy here. Okay. So, you know, so slightly bearish was the next one that I, I had mocked up.

[00:26:21.14] - Speaker 1
So let's just say that we're outright, slightly bearish the market. If you've been out of this market with cash. One of the trades that I really like right now is being, is being just outright short puts.

[00:26:34.17] - Speaker 2
Right.

[00:26:35.18] - Speaker 1
And short dated puts at that. So we know that the put wing, while it's come off a bit, while it's come off a bit, it's still actually, you know, pretty darn close. If you're looking around the, the 500 level on spy, the put wing's pretty close to where it was at the kind of peak of the panic. So we're still getting pretty good vols. I was looking at selling some options for some clients earlier today and again, you know, everything's like, seems to be well above 30% volume that we were looking to sell. So I think you're getting paid a nice premium. So one strategy that I, that I really like for someone who's kind of moderately bearish, you know, so if you, if you're sitting on cash right now and you're long, you know, and you're in money markets receiving say four and a quarter percent interest, which is, you know, I think it's give or take pretty typical for if you look at the various, you know, money market funds out there, they're paying somewhere between 4 and 4% and a quarter, maybe a little higher. If you can do that and then sell puts right now you can add quite a bit of return on top of your cash.

[00:27:45.19] - Speaker 1
Obviously you, you've got to be committed then if it, if it goes in the money to buying spy. But for someone who's saved and sitting out because they thought Spy was overvalued, the question is how low can it go? Right. My fund, we're, we're in the same boat with everybody else. We've been, you know, we've, we've been pretty bearish. We've been concerned about the big sell off. We weren't completely out of the market but, but we were fairly limited leverage and fairly limited exposure to the market. So now the big question, the million, billion dollar question is when do you buy in? How low can we go? You know, everybody's got their own metric. I can tell you that for my fund Stress tests. We, we do stress testing. So not where I think it's going to go, but, you know, I think comparable crises. If we were to turn into something more like it, you know, more like a 2008 or a serious financial crisis, I think we would, we would end up somewhere between 3,800 and 4,500, which is, I know, a wide band, but obviously we're talking about pretty extreme events. So in my mind, if I want to be long 45, you know, if 4,500 is kind of the level where I really want to be all in on the market and even thinking about adding leverage at that point, that's not where you want to start buying, right?

[00:29:03.20] - Speaker 1
You want to start your sales or, sorry, start your purchases much earlier than that. One of my kind of favorite maxims is, you know, as a trader is, you know, don't miss out, like, do some now if you have a view. I think, you know, I think market's going higher. I want to buy in spy at 490. If 490 is where you want to get in, don't wait for it to go to 490. You know, you know, buy to 510, buy it at 520 and then work some extra and then, you know, buy a quarter of it and then work another quarter. You know, buy a quarter at 5:30 and then work another quarter at 500 and then, you know, a quarter at 480. And then if you're wrong and, and it goes much further than you expected, then you can buy your last quarter around 460 or some 470, and you can, you can still get to the same average target. Because the worst thing in trading is when you're right and you don't get your trade off because you were waiting for it to get to your level. And I see that so much with people sitting out of the market, sitting on cash.

[00:30:06.08] - Speaker 1
So this is where this put strategy that I'm about to talk to you all about next. So what I would be doing right now is I'd be looking at kind of, you know, if I. If. Let's just say hypothetically, you've been sitting on some cash, you're trying to figure out where to get in. You'd be interested in entering below 500 on spy. I'd start looking at, you know, say 500 puts, 510 puts, short dated. Cause that's where we're seeing a really, really firm bid for volatility. You know, just looking at what you can get on spy. You know the May 500 put right now. So just going out one month, May five, ten put, trading nine bucks, right? So you're making nine bucks in premium. Your effective break even is 500. And if you think about that annualized, right, that's nine bucks times 12 months, 108, you know, that's divided by and you're putting like $510 at risk. I mean that's a 20 return. You could go quite a bit lower. You could probably even do something like a 470 or 480 put and you'd still get, you know, 5%, 10% annualized. Assuming you can continue to sell those puts every month, will that persist?

[00:31:35.08] - Speaker 1
I don't know. But right now it's a great time for strategies like that. If you had the foresight to be in cash for this big sell off. So you know, that's, that's a strategy I'd look at. If you're trying to kind of find the right entry point so that you don't miss out, you can at least get quite a bit of premium. And then one of the things I'm doing for some of my clients is, is saying, well, okay, you know, each time we collect premium, we can kind of roll our entry point up, right? So let's say we sell the, you know, let's say we sell the 510 call and collect about 10 bucks of pre, or sorry, 510 put in May. We collect 10 bucks in premium. We don't get exercised. You know, it say spy is trading 520. Well then kind of, what's the next step? Well, we can, you know, next we can roll it up and we can say, hey, we're going to do 520 now because we've already collected 10 bucks. So if we can make 10 bucks on the 520, then we'll get, you know, we're still effective.

[00:32:28.28] - Speaker 1
We're getting in an effective price of 500 and we can just keep rolling it up. And as long as the market doesn't run away from us significantly, we got a pretty good chance to get filled at our 500 level after you net out all the put premium that we collected. I know I just said a lot there, but the basic concept is if you're, if you're into the cash secured put strategy, the basic, you know, you can basically roll up your, your target entry level higher and higher and higher with, but you're only rolling it up by the amount of premium you've earned. And so you're really having a You're getting that fixed entry point. It's a way to help you get that. So that's the kind of thing I'd suggest right now for people who are out of the market and looking to get in. If you're nervous, of course, you know, if you're ready to buy now, it's a lot cheaper than it was. You know, by all means, I'm not, not discouraging anyone from buying now, at least getting started. Like I said, with my earlier strategy, right. It's never a bad time to start buying.

[00:33:32.14] - Speaker 1
Let's say you're assigned. Would you then sell short dated calls against it? Absolutely. Great question. Very good idea. And I literally just did that for my client this morning. So we got assigned and you know, so we were short puts, cash secured puts, you know, we still think it's going a little lower. And so we said, hey, well, you know, we just bought it at 4, 4:35 this morning on Spy. And so we said, you know, let's go ahead and sell like a 455 call or four. I think we did 450, 450. We did a 455 call. We said, let's, let's turn on, sell the 455 call. Worst case, market snaps higher. We just locked in a quick, quick return. You know, we locked in a quick 20 bucks on that and we received plus premium. Now obviously if you really, if you're totally under invested in the market, I wouldn't do that turning around and just selling the immediate short dated call. But if you're mostly, you know, if you're, let's say you're, if you have a classic 60, 40, 70, 30 portfolio and you're playing with your kind of cash component or if this is your play money, oh, by all means, you know, go for it, sell the call.

[00:34:43.02] - Speaker 1
Because we're volatile right now. You're getting such a healthy premium that I'd play with it. If I was all the way out of the market, you know, I'd be a lot more careful about that. I'd make sure that I get more bought before I start selling calls against it. You know, like again, this isn't a recommendation I don't give. I, I try to never talk about particular tickers. I don't, I don't form views on single stocks for the purpose of this, of this call or make trade recommendations. But I'm just trying to give you some insight into how I talk to my clients. And you know, I'm telling my clients, if you were holding back cash. For this, you need to at least be 20, 30, 40, 40 bot. Could we go a lot lower? Absolutely. But it's just not that often that we get a 20 sell off high to low. I mean, how often does that happen? Every 10 years? Every 20 years? If we turn around and bounce higher, we may be waiting for another decade for a 20 sell off high to low. Again, I think it could go a lot lower.

[00:35:38.18] - Speaker 1
I think it could even hit, you know, 450, maybe even 380 if things get really, really bad. But, but long term, we know that the right, you know, portfolio position for a long term buy and hold investors to be in the market. So you got to always balance those two things. If you're out of the market, you're missing dividends and you're missing the kind of long term average drift. So great question, Joel. And the last one, so we talked about a bear, we talked about a bullish trade which was to use this, the high short dated volume, and sell that and use that to finance a long dated call. And we talked about a medium, like a kind of neutral trade. If you had cash on the sidelines, you wanted to get it in, but you weren't sure where to enter, you could use a cash secured put strategy. And that's taking advantage of the fact that, you know, we're still getting an excellent bid for these puts right around here at what I think are pretty good entry levels if someone was going to say that they wanted to get into the market. So last, let's look at a bearish strategy.

[00:36:40.27] - Speaker 1
So what if you're like, Ryan, I know you said to buy some now, but boy, this thing's going down. Like, this is the crisis I've been waiting for. I'm not gonna get in too soon. I'm not buying anything with a four handle. Well, we can take advantage of this, of this smile, of this tail. And we could basically say, all right, well, we're getting even more, you know, puts might be expensive right now, but they get even more expensive as we go out. So I look at the one by two put spread, if I was very bearish. So the one by two put spreads, a nice trade, same deal. I'm still, I'm still working with the base assumption that your goal should be to get into the market eventually. But if you're, you know, committed to not buying it with a five handle, that's what I do. So I looked a little earlier, the 520 put here, you know, so if we buy the 520. So if we buy one time, sell two times. So before we were looking at this, if you buy one time, the five, the 520 put. I did this 90 days out, three months out.

[00:37:58.11] - Speaker 1
So the July option, X free. So you'd collect, you'd be paying 22 and a half for a 520 put on spy, and you'd be collecting 25 and change. So you would net about three bucks in premium, and then you would be short the short spy from 520 all the way down to 485. So this is of vertical. Before we did a calendar call spread. Now we're doing what's called a vertical put spread. So that means same X free. Before we did a diagonal, before we did a diagonal call spread because we did different x frees. 11 verse 43 and 535 verse 530 strike and today. And now we're talking about a vertical because we're keeping the 10 are the same. The days to expiry is the same 90 days on each. But we're buying the higher strike put and selling the lower strike put two times. So what's the one by two? The idea there is that we don't want to net pay premium. We want to, you know, slightly receive premium or be flat. We're willing to get along the market, but we want to be up significantly more or we want to be significantly lower before we get into the market.

[00:39:24.25] - Speaker 1
So the way that this trade would work is that once we hit so down to 485, if the market would go down to 485 and settle right there, then we nailed it on our 520 put, we'd be. What's that? 35 bucks in the money. So we'd be, you know, just. We'd be 35 bucks in the money, and we could turn around and buy at 485 and knock 35 bucks off that if we were to just buy the one time, if we bought one share, our effective purchase price would be 4, 450, less the three bucks that we collected for 447. Right. So that's an absolute home run. If we close right around 485, you'd have the. So if you think we're going to 490, you can do this trade, you know, costless, slight premium to you. And if we settle around there in July, you're gonna be, you know, you'll be able to effectively enter SPY at, you know, 440 something. 440, 450. Now, if we start tanking Even lower. If we were to settle at 450 or 440, you're gonna be locked in. You're gonna be buying two shares at 485. And so that's going to start to quickly get, you know, eaten back up on the one by two.

[00:40:49.20] - Speaker 1
I don't have the hockey stick diagram for you all today, but maybe we can send that out later. We'll get that ratio, put spread up. I'll get a diagram of that sent out. I saw a good question asked here, let me pull that up. And it raises a good question. And we'll ask Fabian. We're all figuring this out together. This is a new series, you know, that we've started, the volatility corner. And so the question was, if we have further questions, is there contact info? I'd like to get some sort of mailing list or something set up so that we can start to get questions and ideas that'll help us, you know, drive the discussion for the next one. So for now, go ahead and send it to InfoQ. And then going forward, maybe we can even get one set up, maybe just in the subject line, throw a volatility corner in there. And then, you know, those can get directed to me and we can review a few of those and that can help drive the example in two weeks when we walk through it. I'd be, I'd love to get that going. That'll give people a little more time to formulate their questions.

[00:41:54.05] - Speaker 1
And some of these questions are catching me off guard too. So they'll give me a little time to prep answers and have some diagram. So that's a, that's a, a great call there. So we will, we will get that going. Let's see here. We still got about 10, 15 minutes, so we got a little bit more time to talk through these. So we, again, just a quick reminder, we walked through three strategies that you could use right now to take advantage of current market environment based off your view. Again, I've said this before. You always want to marry your view with, you know, with, with, with what the market's giving you. So last time, last week, we talked about HTZ Hertz. You know, it had a volatility smile that told us a lot. But, you know, the volatility smile was telling us it was, we could get short cheaply. But the flip side of that was HTZ had been beaten down. As I noted on that call, like, hey, HTZ has been beaten down. It's fallen like 75%. So, I mean, you better be Pretty bearish to stay short there. And so ideally, again, these things line up.

[00:43:02.09] - Speaker 1
So I always want to tell you, you know, given a range of views, what the right strategy is. You can also take this logic and apply it to a particular. So again, so what do we do if we're, I'm going to just, you know, repeat things to make sure it sticks. So you know, if we're short term bearish but medium term bullish, we do this diagonal calendar call spread. If we're somewhat bearish and we have cash on the sidelines, I'd start doing cash secured puts closer to the money and then rolling them up to get into the S P at my effect at my target entry price rather than at the current price. And if you're outright bearish, I'd be doing the one by two vertical spread put spread. So you have a much lower entry price. If you get it right, obviously you'll miss out if there's a rally. Okay, so how can we apply some of this stuff to single stocks? So I like to look at S and P because typically you'll see the kind of index level characteristics filter through to other stocks. But not always. Many times single stocks have their own dynamics based on what's going on with that market and what's going on with, you know, the earnings calendar and recent news events.

[00:44:20.26] - Speaker 1
So I just kind of went looking through a few different screeners. So once we, so once we start with the SPX and we have this basic concept. All right, well we know that short date involves pretty expensive, long date involves cheaper. And you know, generally the calls are somewhat expensive. The puts are also still expensive, but the calls are relatively, even more expensive. Also you can see here again the calls have, have joined the puts in being expensive. So.

[00:44:51.14] - Speaker 2
Right, I can, if I can stop you there. For those who have really not seen the volatility surface and the volatility smile, do you want to maybe like go through the smile and maybe show like what you look for? Like, and why? Like if you're looking at stocks, like how can you read this chart to be kind of active and obviously place your option trace based on that?

[00:45:15.11] - Speaker 1
Yeah, so I usually look at this chart a little bit differently. These are in strike space, but we usually think about it in like percentage of strikes of, of at the money or in delta space, which is even better, which is the probability of getting executed. So you know, we would usually start with like the 50 delta, which would be right around here. So you could draw a vertical line right here and say. All right, this is at the money, this is the smile, this is the, at the money implied volatility. So let's say it's I don't know, 30%. So if I sell an option here or buy an option, I'm going to pay about 30 implied volatility. But if I want to move down and buy something on the say, you know, 49, you know, if I'm going to buy like a 490 or 480 on spy, my volatility is going to be considerably higher. I'm going to be paying 40, 42, 45, maybe even as much as 50% to buy a much more expensive put. Now that doesn't. Now obviously because these further outputs have a lower probability of being executed. They're still cheaper, but they're not as much cheaper as we would expect.

[00:46:31.05] - Speaker 1
Because what's the, if everybody remembers there's, there's three inputs into option prices, right? So there's time to expiry. The more time you have till expiry, the more value your option. There's moneyness or like how close to the money you are. I'll call that moneyness. So obviously if the, if the option is more in the money or closer to the money, it has more value. If it's further away, it's less likely to be exercised. So it has less value. And then there's volatility. So volatility is how, how volatile is the underlying. And this is whenever, you know, whenever you forget or you get a little confused with options trades, even, even pros get confused sometimes. Like I told you, I managed in the options book with 500000 strikes. It's easy to look at my book and get confused. And so, you know, we just take a step back and say, all right, well more time is better for me. If, if, if my book shows that I'm losing money as time goes away or I'm losing, I'm losing money as we, as we go up or I'm losing money as volatility goes up, then I can kind of estimate we call those theta delta and vega, which are the Greeks, which, you know, we've done some classes and we'll do some more follow up classes on understanding the Greeks and options.

[00:47:51.14] - Speaker 1
But at the end of the day that's really all it is is saying how exposed am I to these? And an option, if you're buying an option, it's going to have more value if any one of these things goes up or well, money like if it's proximity to the underlying increases so if you're talking about a call option, if the underlying goes up, then your call option's worth more. If the time value goes up, your call option's worth more. Volatility goes up, your call option's worth more. So when we look at the smile. Oops, there we go. If we look at the smile here, what we're saying is that, all right, so I know that for this option, you know, it's worth X. If we move out here to say, you know, the 480 strike, well, now we're much further same time, the smile is always for the same expiry. But if, but out here, we're much further away from the money, so. So we have a much lower probability of getting exercised. Right. But what, what else impacts that probability of exercise? Of exercise? Well, how volatile the underlying is, I. E. How much it can move to get there.

[00:49:08.22] - Speaker 1
And so what this is saying is when you buy an at the Money option, what, what they're kind of telling you right now and what VIX is telling you, VIX is based on at the Money, it's telling you, hey, like, market's pricing in about 30% volatility. So over a year, you can think that the market's going to move about, you know, 30% from where it is today, up or down. And, you know, the daily break even, as I said, is about 32% divided by 15.875. So 32 divided by 15.875. So in a given day, we're going to move like up to 2% would be kind of a normal day. But when you go to buy options out here, you're going to pay more. You're going to pay more like 50 volatility. And 50 volatility divided by 15.875 is 3%. So it's telling you in this state of the world, you're paying for this, you're paying a premium for this option. You're paying a risk premium, you're paying more for the option. As if the market could move much more than what VIX is saying effectively what at the Money volatility is saying, at the Money volatility is saying, hey, market's gonna move about 2% a day.

[00:50:30.18] - Speaker 1
And this is saying, well, you're paying so much for this option that it suggests that it's gonna move 3% a day or more. So even though it's further away from the money, the premium that you pay for it is not declining as fast as we would expect. So. So that's kind of. But for any point on this. So that's the first thing is this tell, this smile tells us relative to an option at another point, is it a, is it more or less than we'd expect? And then we look at the smile relative to where it normally is. So you know, we say, all right, you know, right here at the 450 point, well, this is way more expensive than it was a week ago and whoops. And way less expensive than it was. Sorry, this is way more expensive than it was a month ago and way less expensive than it was five days ago. Now again, there's this mixed thing that there's time value. So you know, also if the options have lost time value. But, but this is for the same strike. So this is telling us that, you know, know again, so for the same strike for that 450 put, you know, that suddenly was much more expensive a week ago and now we're somewhere in the middle and a month ago it was much cheaper.

[00:51:48.18] - Speaker 1
So you know, if you bought, if a month ago you bought 450 puts, even though they're nowhere close to the money, if no time had passed, you would be up, you'd be able to sell them for a profit. Now in practice some time has gone by so your puts have probably lost some value, but not as much as you think because we've had this, this pickup and in implied volatility. So that's how I look at the smile. And again, same thing with the term structure. You know, we're looking for the, we have, we want to compare where they are against each other. So we can say, all right, like one week ago short dated options were much more expensive than long dated options. And also where they are relative to over time. So here, so today we can say that the entire curve is much higher than it was a month ago. But interestingly we can say long dated options are actually higher than they were a week ago at the peak of the panic. And short dated options are cheaper. So if your view is that we're going back to one week ago, so you always have to marry the surface and the surface is just the three dimensional combination of these two, you can draw the term structure for every strike or delta point and a smile.

[00:53:06.13] - Speaker 1
So if you just imagine like a row of smiles, right, like then it makes this 3D sheet and we'll talk through the surface on the next one. So yeah, so you always have to marry your view with a smile. But basically what we can say here is that again the premium for short term options has, has eroded but the market is now baking in higher expectations of long term volatility.

[00:53:34.25] - Speaker 2
Maybe I can share a sneak peek of what we're gonna release it tomorrow. I believe so maybe we can share a little bit of what the trading smile looks like. So here this will be a release tomorrow so you can look at volatility in a 3D surface or in a 2D surface. So if you want to like look at strike versus expiration, look at where the volatility is, soon you're going to have this in the dashboard. So we, we're going to release that on all the different assets. So yeah, and we'll talk more about it in the next few webinars as well on how you can use this data.

[00:54:12.25] - Speaker 1
But yeah, yeah, excellent. Here I'm gonna. So I guess the last thing that I want to mention here, how do I get back to the ticker here? Can I put it in there? Oh, there it. Is. Loading up for hrl. That's not working. Not sure why Here. I had it under one of these volatility screens here. Well I can also send that one out. We'll talk about that one next week.

[00:55:16.18] - Speaker 2
Just try to catch the screen Ryan, if it doesn't work.

[00:55:19.17] - Speaker 1
What's that?

[00:55:20.23] - Speaker 2
Just refresh the screen. If you go back on this is installed. If you guys have any questions, as always, send us an email infodmentorq.com and all these tools that Ryan showed are available via the dashboard.

[00:55:42.21] - Speaker 1
There we go. Yeah, yeah. So I just wanted to give you a quick example. So we talked a lot here about term structure. Right. And SPX and then you can use screeners and I actually forgot which one I used because I like to look through all these screens and so what did we just talk about? We said short date involved was expensive and and longer dated ball was cheaper but that kind of eroded. Right. For spx. When we were looking at spx we saw that, well it's not as juicy as it was five days ago, but look at HRL hormonal foods, right. I mean this is fascinating. Now again I, I haven't done a ton of research into HRL but now you're really for this kind of 10 day option getting a massive, massive short dated premium. And so if you were bullish Hormel foods, you know I'd be looking at buying a 20 or a 50 day call and selling, you know like the 10 day call. So maybe you know they've got a big earnings announcement or something coming out and I'd also check the smile here and yeah look at that. Look how expensive that call skew is there.

[00:57:00.24] - Speaker 1
Unlike the other stuff we were looking at, they've got an almost symmetrical call skew. And so what that tells me is one, we've probably got earnings or a big announcement coming out soon. I haven't even checked, but this is kind of the fun game you can play with, with options. When you look at a single stock, you can actually make a, make an educated guess like, hey, I bet that, you know, I bet that, you know, like earnings must be coming out because there's a, a big peak when we looked at term structure and there's a big premium for the calls. So maybe people are worried about or expecting bullish, bullish earnings. So if I was a bull on hrl, which is sold off, you know, quite a bit, you know, I'd certainly be looking at that same trade we discussed for SPX or spy. And that's going to be even juicier during hrl. So, so the idea here is I'm not telling you to go out and make a trade on HRL by any means, but you can look at the characteristics that we talk about in our discussion about SPX and you can go look for stocks that you do have a view on and go see if they exhibit those same characteristics as spx.

[00:58:13.02] - Speaker 1
In an ideal world they'll have, you know, and a more exaggerated because the SPX tends to sort of smooth things out because it's a blank end of, you know, 500 names. So when you go look at a single stock, you'll see some single stocks have a very extreme inversion in the term structure like here and then others will be more muted than spx. So then if we talk about your strategy or you like that concept, well, now you go find a single name where you have a view. So if you said, okay, you know, Ryan said that, you know, right now we're getting, it's cheaper to finance long dated calls with short dated calls, relatively speaking. So I'm going to go find a stock that I'm bullish and, and has a big positive term structure, an inverted term structure. And now you suddenly can start to put together the full concept of a trade idea. So that's how I'll close that for this week. But hopefully we can start to each, every two weeks we can start to draw this out. How you can move from a quick overview of the market to executing trades for yourself.

[00:59:14.04] - Speaker 2
This was awesome. Thank you, Ryan and thank you guys and Happy Easter to everyone. So we're gonna have a, a long weekend we're gonna be back next week, so I think we're gonna be back with you Orion in a couple of weeks. So we're going to talk more about volatility strategies and how to read the data. And for those who want to learn more about us, send us an email at info and mentor Q if you have questions on the session, please don't hesitate to contact us and see you guys soon.

[00:59:44.19] - Speaker 1
Yeah, have a happy Easter. Put Volatility corner in the subject line with your questions if you want me to try to take a look at them and prep some points for the call in two weeks. Yeah. Good luck. Good trading.

[00:59:58.02] - Speaker 2
Have a good one. Bye, Ryan.

[01:00:00.10] - Speaker 1
Thank you.