Bull Market in Volatility
Back on January 27, I wrote about a new bull market that most investors were either overlooking or just didn’t have the wherewithal to know how to trade.
That’s right, volatility, if used correctly, is offering us some of the best opportunities in years.
Just look at the IV rank in the major benchmark ETFs.
*IV Rank – tells us if current implied volatility (IV) is considered high or low on an underlying security in comparison to all other IV readings over the past 12 months.
IV rank is calculated by taking the highest IV reading and lowest IV reading over the past 12 months.
For example, if a stock has an IV range between 40 and 80 over the past 12 months and the IV is currently 60, the stock would have an IV rank of 50%.
The charts below show just how high volatility is at the moment in comparison to the last 10 years.
Typically, when the IV chart is shaded pale green or higher, options selling strategies become far more appealing. But when we see IV rank pegged, like it is now, well, it’s time to open up the playbook.
S&P 500 (SPY)
Nasdaq 100 (QQQ)
Dow Jones (DIA)
Russell 2000 (IWM)
Images courtesy of Slope of Hope
Every single underlying ETF has an IV rank that is nearly pegged. But it’s not just the major market ETFs.
We are seeing inflated levels in Gold ETF (GLD) and various other ETFs and blue-chip stocks.
The New Bull Market – Volatility
For weeks I’ve been writing about the heightened levels of implied volatility that we are witnessing in the market. And how a high IV environment offers those that trade options the ability to start selling inflated premium.
Now, as I’ve stated numerous times in the past, I use options selling strategies almost exclusively. Yes, I will use debit spreads from time to time, but my true focus relies on having a statistical advantage with each and every trade I place. Therefore, options selling strategies remain at the front of my quiver at all times.
Over the past few weeks, I’ve discussed various ways to take advantage of the inflated premium in gold.
The latter was a bull put spread that will expire worthless for a 10.4% return. Certainly not huge, but I’ll take it. Singles and doubles are the ultimate goal.
And since the IV rank continues to remain high in GLD, let’s take a quick look at what kind of premium we can receive with a high-probability trade.
Gold, as seen through SPDR Gold Shares ETF (GLD), continues to trade in a range between roughly 160 and 180.
Given the heightened IV rank, we know premium is inflated. And if your preference is to use a risk-defined options selling strategy, a bull put spread, bear call spread or iron condor offer the most practical approach.
As you can see, the expected move for GLD for the April expiration cycle is from roughly 169 to 186, so my goal would be to place a trade outside of the expected move.
An iron condor would certainly be a viable strategy choice. I could sell the April 190/195 and 165/160 iron condor for roughly $0.80, or a 19.0% return—a trade I will probably discuss in further detail next week.
But, like last time, I want to take a look at an alternative trade using a bull put spread.
A bull put spread, otherwise known as a short put vertical spread, is one of my favorite risk-defined options strategies.
As the name of the strategy implies, a bull put spread is, well, a bullish-leaning strategy.
But it is important to note that the strategy doesn’t require the security to move higher to make money. With bull put spreads you not only have the ability to make a return when a security moves higher, you can also make money if the stock stays flat or even if the stock pushes slightly lower.
The first step in placing a bull put spread, or any trade, is making sure the security we are interested in is highly liquid. We always want to use the most efficient products possible. It just doesn’t make sense to have to make 5% to 15%, possibly more, to get back to breakeven.
SPDR Gold Trust ETF (GLD)
GLD is a highly liquid product, so we can move forward with a potential bull put trade.
As seen in the chart above, GLD is trading for 177.25.
The April 14, 2022 expiration cycle with 56 days left until expiration fits the bill. As a result, let’s take a look at the put strike with approximately an 80% probability OTM (out-of-the-money), otherwise known as the probability of success on the trade.
It looks like the 168 put strike, with a 78.73% probability of success, is where I want to start. The short put strike defines my probability of success on the trade. It also helps to define my overall premium, or return on the trade.
Once I’ve chosen my short put strike, in this case the 168 put, I then proceed to look at a 3- strike wide, 4-strike wide and 5-strike wide bull put spread to buy.
The spread width of our bull put helps to define our risk on the trade. The smaller the width of the spread the less capital required. When defining your position size, knowing the overall defined risk per trade is essential. Basically, my spread width and my premium increase as my chosen spread width increases.
For example, let’s take a look at the 5-strike, 168/163 bull put spread.
The Trade: GLD 168/163 Bull Put Spread
Sell to open GLD April 14, 2022 168 strike
Buy to open GLD April 14, 2022 163 strike for a total net credit of roughly $0.60, or $60 per bull put spread
- Probability of Success: 78.73%
- Total net credit: $0.60, or $60 per bull put spread
- Total risk per spread: $4.40, or $440 per bull put spread
- Max Potential Return: 13.6%
As long as GLD stays above our 168 strike at expiration in 56 days, I have the potential to make 13.6% on the trade.
In most cases, I will make slightly less, as the prudent move (and all research backs this up) is to buy back the bull put spread prior to expiration. Typically, I look to buy back the spread when I can lock in 50% to 75% of the original credit. Since we sold the spread for $0.60, I want to buy it back when the price of my spread hits roughly $0.30 to $0.15.
Of course, there are a variety of factors to consider with each trade. And we allow the probabilities and time to expiration to lead the way for our decisions. But taking off risk by locking in profits is never a bad decision and by doing so we have the ability to take advantage of other opportunities the market has to offer.
Since we know how much we stand to make and lose prior to order entry we have the ability to precisely define our position size on every trade we place. Position size is the most important factor when managing risk, so by keeping each trade at a reasonable level (I use 1% to 5% per trade) allows not only the Law of Large Numbers to work in your favor…it also allows you to sleep well at night.
Moreover, I like to take off the trade if my original credit, in this case $0.60, reaches 1x to 2x my credit. So, I would look to take off the trade if it hits $1.20 to $1.80.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below. And don’t forget to sign up for my Free Newsletter for education, research and trade ideas.