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In this article we’d like to explain adjustment beliefs which can be practical in running an options account. This individual strategy can be practical to each and every type of option spread such as the Credit Spread, Iron Butterflies, Iron Condors, Double Diagonals, as well as others.
As this is being written in October of 2008 the VIX is as high as it’s been. Look at a 5 year chart and see where we are. This level of volatility has made options quite expensive. Before we make any adjustments to our portfolios, we always think about the volatility. Where is it now and where is it going? Should we be buying or selling options at this moment?
A very common mistake that option traders make is buying or selling options at the wrong time. If we buy options when the volatility is at a high, we are entering a trade with odds against us. Option traders that do this don’t realize why their options lose value so fast. Every option trading adjustment should be made by thinking of the option Greeks and volatility. We really need to understand these fundamentals to succeed in the options market.
A TYPICAL OPTION POSITION THAT MIGHT NEED AN ADJUSTMENT
For example, we have on a Butterfly spread and the market has been up-trending for a few days. In this case we might need to make an adjustment on the Butterfly or possibly on our whole portfolio. Options trading requires some management or we can take on great amounts of risk. So, if this is the situation, we’d be looking at adjustment ideas with IV in mind. We’ll study our price chart and also the IV chart. Perhaps we’ll find that the IV is on support now, and it looks like it’s going to rise again.
There are many option strategies and morphing concepts, so how can we make a good decision on what to do in this case? A critical step in the decision making is graphing the current volatility inside the options market. We usually use the VIX and RVX. Is the volatility bottomed and increasing? Is it at a peak and coming back down? Is it barely moving? What is happening in the options market and where is the volatility in relationship to its history? We additionally need to study the technical analysis of our traded asset. Where is the price headed? We have to comprehend Vega and the other option Greeks to accomplish high probability changes to our positions. In today’s example, if the volatility prediction is up, it would make sense to add some positive Vega to our portfolio.
There is really an unlimited number of ways to create a positive Vega position, but the most common positive Vega spreads are Debit Spreads, Short Butterflies, Broken Wing Butterflies (OTM), Short Condors and Calendars. In our mentoring course we discuss option strategies and adjustments in detail.
To conclude, if the stock market moves against you when you are in an option spread, then always study the IV of your underlying asset. Knowing what is going on with volatility can really help you make better decisions on managing your portfolio. This will definitely reduce your exposure to risk while increase your chances of being a profitable trader.
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