When volatility is up and rising in markets, would you rather be a buyer or seller of option premium? Actually, you would rather be a buyer if you were a momentum player, especially when markets are trending up or down. Contrarily, when volatility is flat and low you might want to hedge when options are cheap. But, when are the best conditions to be a seller of premium?
I have found the best time to sell premium is on a spike high in volatility that is far outside the norm. Often we find these extreme moves are exaggerated and reflect emotional responses to uncertainty and an unclear future. It’s always better to be safe than sorry, buying insurance and getting ready for ‘the big flood’ that usually never happens. With strong gains this year who wants to lose those nice wins, further who wants to be the last one in the room before the lights go out?
The markets tell us what to do, where to go and direction. Looking at the bigger picture and not making assumptions about the effects of this meeting or that deadline makes our job and decision that much easier. So, when a day like Friday occurs I see opportunity. As the day was coming to an end, the volatility index was rising – spiking to new highs but the market really was not moving too much. Apparently some SPX puts were being bought as protection in case the folks in Washington decide to shutdown the Government (deadline is Sept 30). So, how do you handle these spikes?
For most of 2013 these spikes have been temporary and been great premium selling moments. Just look at the chart of the volatility index (VIX) above and you can see what I’m talking about. Friday saw the VIX spike end of day, rising nearly 10% in fear the markets may sell off early next week. But having lived through the recent turmoil caused by government impotence (see: 2011 and late 2012) there is evidence the fear is unwarranted and have presented great trading opportunities. As an options trader, my preferred choice was to sell SPY or QQQ put spreads.
When it feels the worst and uncertainty is apparent then fear rises and so does the VIX. The premiums rise, especially on puts – which have been the best vehicles to sell all year long. When the event passes we see volatility deflate, premiums drop and gains can be booked (buying back puts or spreads). We’ll see next week if this was the right move, but if history of 2013 is any clue then it was probably another great chance to profit.
