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Thursday, June 20, 2019

Should I sell options during low volatility environments?

A reader recently contacted me with the following question:

"I was just curious about how to approach low Implied Volatility with the strategy. Do you still trade the strategy during times of low volatility or wait for higher IV and stay out of the market?"



To clarify, he is referring, among all the things I do, only to the  neutral trading, Option Premium selling oriented via Iron Condors, Elephants or just simple Credit spreads, whose results by the way are available here.

Good question.

The thing with the financial markets is that there is rarely a bullet proof answer, a never-fail situation, a "must do". It's a pretty chaotic environment where nothing works all the time, even using 'good/safe' practices with a long term positive edge.

Trading during low volatility. The problem with not doing it is that you never know when volatility will be more attractive.

For example, the entire 2017, where I made 20.3%+. If you look at volatility it was severely depressed all year long. Had you been waiting, you would have perhaps just made one or two trades in an index for the entire year.

Now, it is undeniable that selling Options when volatility is higher is better: more attractive premiums, farther away from the money. But if you look at some studies, for example by   http://dtr-trading.blogspot.com/  or even tastytrade, they all show that the activity is still long term profitable (only less so), in low volatility environments.

Remember that volatility plays a role in pricing of options, but so do the stock/indexes moves (delta) and the passage of time (theta). Volatility is not the only vehicle.

I understand the challenges. Some traders may just decide to never use options selling strategies during low volatility and even go as far as to establish a hard rule like "stop doing it when the VIX is below 15" or whatever the number. But in this case you risk staying in cash for far too long. And then in the middle of the frustration you start forcing trades. Trades you may feel uncomfortable with.

One possible approach is to decrease your level of activity during low volatility environments (fewer trades and/or smaller position sizes) and to increase it (more trades or slightly larger position sizes) during high volatility.

Personally, what I have done is I have a "permanent, leveraged portfolio" where there is no active trading. Just long-term investing. It uses ZIV (short volatility medium term ES futures),  UPRO (triple leveraged SPX) and TMF (Triple leveraged bonds as hedge). When volatility is getting too low or even staying sideways ZIV is almost permanently going up. So, you feel great. Obviously it falls when volatility goes up, but in that scenario, the triple leveraged bonds are usually going up. So, it is a nice hedge. Also, if vol is going up, now, the other portion of capital used for active trading in the account is ready to deploy some options selling strategies at a more attractive volatility level. Here's the series on The leverage portfolio http://www.the-lazy-trader.com/2017/11/leveraged-instruments-to-lazily-beat-the-markets.html. It is a four part series, and I hope it helps people out there, for those still unfamiliar with it. The results of this complimentary approach are tracked here.

Until the next time,
Cheers,
LT


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