I have spent the past few days explaining to you option traders that the next two weeks might not be the best time to be short premium. While I believe this to be true, I do not want you traders to think there is nothing to trade out there. There are certain trades that can make sense right now. I also thought it might be a fitting time to discuss when the more standard income trades might start to make sense.
Right now we have these conditions:
2 year low in the implied volatility (really almost 3 year lows)
Relatively steep skew
A market that is slow moving but trending
A bunch of holidays and tons of time priced out of options
In these types of markets the traditional condor is a bad idea. If you think they priced out that ATM IV aggressively, you should take a look at the ‘junk’ 10-15% out of the money that most condor traders like to sell. Traders that set up condors by percent out of the money should be have noticed the large decrease in premium collected.
Traders that use delta have to be more careful, the premium they collect from a trade's premium is unlikely to have changed much from month to month. However I a condor set up in the the major indexes it is going to be 10-50 points tighter than it was this time last month. This is a subtlety that many option traders miss when they only trade based on delta.
Standard 30 day flies do not make sense right now because much of the premium that is left in the fly will not be collected until after the New Year. Why be open on a big fly when one is only collecting 50% of the premium that one should for the risk? Time spreads also look terrible based on the term structure, double diagonals even worse!
So what is a trader to do, my answer, the short term fly, tomorrow weekly options get listed on many stocks those make sense, quarterly options that expire on the 31st make some sense as well. I am not normally in love with cheap butterflies but as long as we have a nice slow market, these flies might make sense.
With a payout of 4 to 1 and a better than 20% chance of working the above fly does not look bad
I like them because they have a very low net risk this is caused by the tightness of the fly and the proximity to expiration. Many times this type of fly will have a pay out of at least 3 to 1, if not 4 to 1. Add this to one's understanding of time decay (ATM’s decay faster than OTM options during the final two weeks), and we have a recipe for success. The key of course is to manage the risk and be disciplined. I don't hate ratio spreads either.
Finally, the magic question: when will it be okay to sell again? My thoughts? I think next Monday might be the first day where it might make sense…if conditions are right. At that time a standard butterfly might have the right risk-reward. All of this goes out the window if we have a major IV pop. Sadly, it might not be until March or April till we see a decent condor sale again.
Don’t forget the new issue of Expiring Monthly is out subscribe here. Also, do not forget to listen to my podcast, the Option Block you can catch the latest one here.
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graph from TOS
