Some folks trade it, I fear it… here’s why:
With high volatility comes high prices. Call options with normal Implied Volatility (IV) at, say 8% may produce ‘at the money’ options costing, say $1.20. Conversely, IV at 30% which we have seen recently and much higher, may produce call options costing $2.00. To gain 6% on the calls costing $1.20, that would be a required 7 cents. For the latter, a 6% increase would be 12 cents. Assuming a delta or .50, that means the underlying stock would have to rise .14 (.07 / .50) for the 1.20 calls and .24 (.12 / .50) for the calls costing 2.00. Granted there is greater movement and you may well get it, no problem
The other issue is that when they pull the volatility out of the options, your option values suddenly drop. That option you just paid $2.00 for may be worth $1.70 very quickly. You not only have to make up the .30 but the stock has to rise .30/delta… and that may not be so easy.
A third reason I avoid high volatility is because volumes and open interest tend to drop off, making your purchases less liquid. It appears that the smart money sits on the sidelines when high IV is presented.
It is for that reason that I tend to withdraw from highly volatile options. I prefer to invoke a measure of safety into my trades. Ultimately, it is the safer trader who will win out. Remember, there are old traders and there are bold traders but there are no old, bold traders.
Hugh W. Grossman, Head Trader at Day Trade SPY.
Hugh Grossman is the founder and Head Trader at DayTradeSPY and uses his vast experience to teach his methods to make consistent daily gains trading SPY options. Join Hugh in his interactive Trading Room to see how he regularly pulls in the profits!
Want to learn how to day trade SPY options? Join us in Hugh’s Trading Room – a program designed to fast track you to success. You will be able to watch Day Trade SPY traders, Hugh and Alex, daily in an interactive setting. Subscribe here.