I sell volatility short. Simple as that.

My job as a trader to to find a stock or fund symbol with high implied volatility on its options, and to sell that volatility at a high price in the hopes of buying it back low price later on.

I do it by selling iron condors — a bull put spread and a bear call spread tied together in a single conceptual structure — usually using the iron fly variant, where the short legs of both spreads have an identical strike price. My profit relies on the premium I receive and on how wide I can reasonably make the wings of each spread.

I often think of it in terms delta, placing the short legs around delta 50 and the long legs around delta 10. (See the table in any of my recent analyses for an example of how I think about it.)

But how high must volatility be before it’s high? And how low is too low?

Important questions without a clear objective answer. Let’s explore some possibilities.

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Lowe’s Companies Inc. (LOW)

Update 5/25/2017: LOW gapped to the downside after earnings were published and then recovered about half of the loss. I exited at 43.9% of maximum potential profit.

Shares showed a net decline of 2.2% over two days, or a -401% annual rate. The options position produced a 78.3% yield on debit for a +14,296% annual rate.

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LOW publishes earnings on Wednesday before the opening bell.

I shall use the series of monthly options that trade for the last time 10 days hence, on June 2.

Implied volatility stands at 27%, which is 2.5 times the VIX, a measure of the volatility of the S&P 500 index.

LOW’s IV stands in the 71st percentile of its annual range and the 77th percentile of its most recent broad movement.

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Advance Auto Parts Inc. (AAP)

Update 6/1/2017: AAP’s earnings announcement after two straight gaps to the downside, and after the announcement gently retraced a small portion of the decline. On the chart, it’s appears traders were following Nathan Rothschild’s time-worn dictum, uttered in 1810 during the Napoleonic Wars: Buy on the sound of cannons, sell on the sound of trumpets. The trumpets in this case allowed me to exit at 28.4% of maximum potential profit.

Shares showed a net decline of 4.4% over nine days, or a -178% annual rate. The options position produced a 39.7% yield on debit for a +1,609% annual rate.

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AAP publishes earnings on Wednesday before the opening bell.

I shall use the series of monthly options that trade for the last time 24 days hence, on June 16.

Implied volatility stands at 37%, which is 3.4 times the VIX, a measure of the volatility of the S&P 500 index.

AAP’s IV stands in the 77th percentile of its annual range and the 96th percentile of its most recent broad movement.

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iShares MSCI Brazil Index (EWZ)

Update 6/2/2017: I have exited the second round of my EWZ, wrapping the series. Here are the results for the series as a whole:

Shares rose by 1.0% over 10 days, or a +38% annual rate. The options position produced a 14.9% yield on debit for a +545% annual rate.

I considered rolling forward for yet another around, but implied volatility as dropped below the 50th percentile of both the annual range and the most recent movement. Even so, IV is 3.5 times the VIX, which is a high level.

If conditions improve, I shall return to EWZ, starting a new series.

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Update 5/26/2017: I exited the May 23 position EWZ for a small profit, a week before the options, and re-established the position with adjusted strike prices and a June 16 expiration. In rolling the position forward, I shall treat the entire series as a single trade for the purpose of calculating results.

In the May 23-26 leg, shares rose by 2.98% over three days, or a +363% annual rate. The options position produced a +2.4% yield on debit for a +293% annual rate.

The new position is structured like this:

Premium:	$2.40	Expire OTM
EWZ-iron fly	Strike	Odds	Delta
Long	40.50	94.1%	7
Break-even	37.90
Short	35.50	50.9	53
Puts
Short	35.50	49.0%	47
Break-even	32.90
Long	30.50	88.8%	9

The premium is 48% of the width of the position’s wings.

The risk/reward ratio is 1.1:1.

The stock at the time of entry was priced at $35.60.

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EWZ has sufficiently high implied volatility to warrant consideration as a volatility play.

I shall use the series of weekly options that trade for the last time 10 days hence, on June 2.

Implied volatility stands at 41%, which is 3.8 times the VIX, a measure of the volatility of the S&P 500 index.

EWZ’s IV stands in the 65th percentile of its annual range and the 64th percentile of its most recent broad movement.

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5/23 – 3;20 p.m. New York time

I have entered new position on AAP, EWZ and LOW.

I have exited no positions. I have an exit order in on CPB that appears unlikely to be filled. I shall keep the order active until the closing bell.

I posted an essay exploring the uses of implied volatility and how to judge its level for the purposes of trade selection, appropriately titled Implied Volatility: High or Low?

5/23 – 10 a.m. New York time

In addition, I shall also be looking at rolling forward with another position on EWZ, the one liquid exchange-trade fund with decently high implied volatility.

5/23 – 9:50 a.m. New York time

I shall be posting an analysis of AZO as an earnings play today. Open interest on LOW’s options remains lower than is compatible with my guidelines. Honestly, as earnings season winds down and trades become scarce, I’m tempted to bend the liquidity rules. Final decision: Still pending.

I have placed an exit order at my target price on CPB that has yet to be filled.

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AutoZone Inc. (AZO)

AZO publishes earnings on Tuesday before the opening bell.

I shall use the series of monthly options that trade for the last time 25 days hence, on June 19.

Implied volatility stands at 25%, which is 2.2 times the VIX, a measure of the volatility of the S&P 500 index.

AZO’s IV stands in the 77th percentile of its annual range and the 78th percentile of its most recent broad movement.

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Apple Inc. (AAPL)

Update 6/2/2017: I entered AAPL as the price began a steady sideways move in order to take advantage of time decay. The position did not disappoint. I exited at 25.1% of maximum potential profit, a bit above my target price.

Shares showed a net decline of 0.2% over 11 days, or a -8% annual rate. The options produced a 33.4% yield on debit for a +1,109% annual rate.

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AAPL has sufficiently high implied volatility for consideration as a volatility play.

I shall use the series of monthly options that trade for the last time 25 days hence, on June 16.

Implied volatility stands at 19%, which is 1.7 times the VIX, a measure of the volatility of the S&P 500 index.

AAPLs IV stands in the 47th percentile of its annual range and the 64th percentile of its most recent broad movement.

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5/22 – 3:30 p.m. New York time

I entered a position on AAPL as a volatility play without an associated earnings announcement. My analyze of AZO showed it to be a reasonable trade, although I passed on it for my accounts because of the high price per contract.

In addition to the five exits this morning — EWZ, LB, XOP CSCO and DE — an exit order on TJX was filled late in the trading day. All analyses have been updated with results.

I have an exit order in on CPB that has not yet been filled. I shall leave it active until the losing bell and update if the order goes through.

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5/20 – 11 p.m. New York time

Portions of two positions expired without value on Saturday, and I have updated their analyses with results. They are LB and YELP.

By Tim Bovee, Portland, Oregon, May 20, 2017

 

The gross domestic product statistics providing a second estimate for the 1st quarter will be published on Friday at 8:30 a.m. New York time. Durable goods orders will be released concurrently.

Two real estate reports will punctuate the week: New home sales on Tuesday and the far larger existing home sales on Wednesday, each at 10 a.m.

Also out: the Purchasing Managers Institute composite flash report on Wednesday at 9:45 a.m., Federal Open Market Committee minutes from the May 2-3 meeting on Wednesday at 2 p.m. and international trade in goods on Thursday at 8:30 a.m.

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