Nothing has changed!
Volatility continues to remain high across the board. In fact, volatility in SPY has increased over the past few weeks. Moreover, the IV rank and IV percentile of SPY remain high, which means there are plenty of opportunities to use a variety of different options selling strategies.
As I’ve stated numerous times in the past, as volatility increases (or at least remains above normal levels), trading opportunities increase, which opens up the options playbook significantly.
Bear call spreads, among other credit spreads (bull puts, iron condors, etc.) using highly liquid ETFs, are one of my favorite defined risk, options strategies in a high implied volatility environment.
Sample Trade: Bear Call Spread (SPY)
The IV rank and IV percentile in SPY continue to be inflated, hitting extremes with an IV rank of 96.83, a level not seen in years.
As a result of the inflated premium, now is the perfect time to start selling some premium in SPY, and most of the highly liquid ETFs like DIA, IWM and numerous others.
Let’s say we decide to place a trade in the highly liquid S&P 500 (SPY) going out roughly 30 days until expiration.
With SPY trading for roughly 390.49, the expected move, also known as the expected range, is from roughly 414 to 368 for the June 17, 2022 expiration cycle that ends in 28 days.
In most cases, my goal is to place my short strikes outside of the expected move. Moreover, I prefer to have my probability OTM, or probability of success around 75%, if not higher, on both the call and put side.
Choosing Expiration Cycle and Strike Prices
Since I know the expected range for the June 17, 2022 expiration cycle is from 414 to 368, I can then begin the process of choosing my strike prices. Because I am using a bear call spread (bearish leaning strategy), I am only concerned with going above the 414 call strike.
Bear Call Spread – Trade Example
The high side of the expected range is, again, 414 for the June 17, 2022 expiration cycle, so I want to sell the short call strike just above the 414 strike, possibly higher.
As you can see above, the 417 strike with an 85.78% probability of success fits the bill.
Once I’ve chosen my short call strike, I then begin the process of choosing my long call strike. Remember, buying the long strike defines my risk on the upside of my iron condor. For this example, I am going with a 5-strike-wide bear call spread, so I’m going to buy the 422 strike.
As a result, I am going to sell the 417/422 bear call spread for roughly $0.68.
Again, it’s all about the probabilities when using options selling strategies. The higher the probability of success, the less premium you should expect to bring in. But as long as I can bring in a reasonable amount of premium, I always side with the higher probability of success, as opposed to taking on more risk for a greater return.
Again, we can sell this SPY bear call for roughly $0.68. This means our max potential profit sits at approximately 15.7%.
Again, I wanted to choose a bear call spread that was outside of the expected move and has a high probability of success. This is why I sold the 417 calls.
Remember, when approaching the market from a purely quantitative approach, it’s all about the probabilities. The higher the probability of success on the trade, the less premium I’m able to bring in, but again, the tradeoff is a higher win rate. And when I couple a consistent and disciplined high probability approach on each and every trade I place, I allow the law of large numbers to take over. Ultimately, that is the true path to long-term success. I’m not trying to hit home runs. I understand the true, consistent opportunities, particularly when seeking income, come with using high probability options strategies coupled with a disciplined approach to risk management—the latter being the most important.
Managing the Trade
I typically close out my trade for a profit when I can lock in 50% to 75% of the original premium sold. So, if I sold a bear call spread for $0.68, I would look to buy it back when the spread reaches roughly $0.30 to $0.15. However, since we are so close to expiration, I might ride the trade out until it expires worthless, thereby reaping a full profit. As always, the market will dictate my actions.
If the underlying moves against my position I typically adjust the untested side. Most roll the tested side, but all research states that rolling the untested side higher/lower allows me to bring in more premium and thereby decrease my overall risk on the trade. Moreover, I look to get out of the trade when it reaches 2 to 3 times my original premium. So, in our case, when the bear call hits $1.40 to $2.10.
Ultimately, position size is the best way to truly manage a trade. We know prior to placing a trade what we stand to make and lose on the trade, and therefore we can adjust our position size to fit our own personal guidelines. Bear calls are risk-defined, so it’s important to take advantage of their risk-defined nature by staying consistent with your position size for each and every trade you place. Remember, it’s all about the law of large numbers.
As always, if you have any questions, please do not hesitate to email me or post a question in the comments section below.