Low Option Volatility Means Vertical Spreads

by Adam Warner | April 6, 2011 11:19 am

Look out below in volatility. We noted the other day that stocks themselves were moving at a snail’s pace since the mid-March hiccup.

Well, options trading[1] investors have found that the snail has gotten even slower. Here’s 10 day Historical Volatility (HV) in S&P 500 Index Options (CBOE: SPX[2]) over the last 3 months.

Yes, we have hit 6.

The CBOE Volatility Index (CBOE: VIX[3]) proxies market estimates of volatility in SPX going forward 30 days. And even though 17 seems low compared to where we often see it, not to mention the backdrop in the world now, it actually seems quite high if the market is only actually moving at a 6 volatility pace.

Of course we don’t know what the future brings. The market would have to trade at a 6 volatility pace for an awful long time for VIX to even get near there. What we can see definitively though is anyone who locked in option longs over the past few weeks has gotten mauled from every front. Time ticked away, options volatility drifted, and the market stopped moving. A 6-volatility implies SPX sees a daily range less than .4% on two of three days, very low to try to trade against.

All that means is that options *were* a sale looking backwards. But it doesn’t mean we should sell 17 volatility now. In fact check out that chart again. The 10-Day HV hit 5 back in mid February, then shot up as high as 20 by mid March. Not saying that will happen again, but the point is it could happen. And so long as the market has that fresh on the radar, options won’t get all that much cheaper just yet.

If you’re of a mind to sell options into this, I’d probably go with spreads. Sell call verticals instead of straight calls, and Iron Condors, where you sell both out-of-the-money call spreads and out-of-the-money put spreads, also feel timely now.

Follow Adam Warner on Twitter @agwarner.

Source URL: https://investorplace.com/2011/04/treat-low-option-volatility-with-vertical-spreads-vix-spx/

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