Liberal Forum

Fuelman » Today, 10:29 am » wrote: ↑

Today, 10:29 am

You going to hold those puts a few days more?

Monday will be a toss up but I wouldn't be surprised if the slide continues.

No, I am only holding short positions against gold miners, gold, and At&T stock. Those are less than halfway to their bottoming point and have much more to fall. 

The others fell much harder in the selloff and while there is still room to fall, I calculated the gains and determined it wasn’t worth it due to something called “IV compression.”

Let’s say you buy a call option on a stock currently at 100, that normally has an IV (implied volatility) of 30%.

The stock surges to $120. You calculate the likely next topping point at $130. The question is do you hold? The answer isn’t that simple. 

Because the stock moved unexpectedly (unexpected by the market’s views, not yours), the IV surges to 65%. This IV expansion is basically a “bonus” to the gains you already made. 

Basically, if you choose to hold until $130, yes the additional price movement will increase the value of your calls, but you deal with the risk that the IV by then will have settled to its normal baseline of 30%. Your “IV expansion” bonus gets wiped out. 

Many of the options I sold have downside left, but the IVs almost doubled. This is a 2-3 standard deviation event (very rare) and I determined it wasn’t worth it, because now I not ONLY have to deal with the risk that there is a sudden, frenzied rally in the stock, but the IV gets crushed back down.