The Option Pit Method Option for Stock Investors

The Option Pit Method Option for Stock Investors Option Pit

What we will cover? • • Strategy Selection- Index, ETF or Stock How to get long, risk adjusted Using volatility to help for long term entry Deciding on calls or puts

What is the underlying? • Stock hedging strategies are different from index hedging, why? – Easy for a stock to move 10% in a week and for an index If you don’t think the stock can outperform the SPX, you should not own it since SPX is less of risk for the same return “Type” of move is important since that helps outline the strategy

Index and ETFs • Index puts can kill a return for the SPY since you absolutely need to close them to outperform – That is a big hurdle and is a factor in how we use them. – SPY protection needs to be financed to really be viable or we look to replace SPY with options • At the end we discuss this

Velocity in the Market • First define the velocity (direction) of the market of the product you are interested in It is usually one way… and then… rising realized volatility and implied volatility… then Here are products I am interested in and then we look at what makes them cook- • Is it a downtrend or has it flipped to a no trend? SPY • Is the realized volatility accelerating or declining? NVDA • Is implied volatility still at the upper end of the range or has it dropped? AAPL • Deciding on entry point in low realized volatility YNDX

Acceleration Now define the acceleration in the product? Is the direction the underlying moving with force? -Rising Realized Volatility Is the direction relatively listless? -Declining OR Flat Realized Volatility

Duration of trade is Key • Real simple- stay away from rising realized volatility at high levels selling short term options – A little pick up in RV is nice if the name has been in the dustbin since this means renewed interest • Now figure out practical longer term strategies – Shorter term means a smaller move – Longer term we want a bigger move

Position Keys by Volatility • Higher implied volatility usually wants a longer term option sale to cushion some short term realized volatility • Lower implied volatility usually wants to buy longer term options • Higher realized volatility generally wants us to buy options • Lower realized volatility generally wants 0 decay or positive decay choices

NVDA has been ugly

NVDA has been UGLY! • Some assertions- selling puts in bull markets can work for a very long time- until it doesn’t – This is a test for most people- me too! – Sometimes a long call is better since the upside is there • The question is can you live with it? – Selling puts in NVDA is tempting but a big risk – The carrot is the 50% drop from highs • We want some real upside and some time to do it

Using Option Prices for Longer Term hedged trades

Using Market Information • The NVDA Jun straddle is right around $30 • I want the position to generate nice dollars after a $30 move. Let’s price that out– NVDA Jun 160/190 call spreads have a nice return • Can we improve the risk/reward profile

Defense • Defensive positions are more passive types of put selling Consist of Put, Put Spread sales AND Diagonal Put Spreads (for credits) We are looking for IV and RV to decline

Short put • After the RV and IV move – THIS IS A STOCK YOU CAN OWN. Test 1 • Realized Volatility- want RV to below the IV and RV to be in the low end of the range -declining state of realized volatility - is the market done selling this? -from a high state to a low state of RV

Short put • Implied Volatility- IV has to be higher than the HV (edge) -don’t want to sell very high IV but mid to lower is ok Remember there is no gamma cushion in this trade at all!

Offense and Defense • Offense consists of trading options looking for an aggressive change in inputs – Is a put hedge possible against put spreads? • Lets look at AAPL to see if a hedge could work • Defense consists of trading options looking for small to no change in inputs

AAPL and long term trade • AAPL stock price has recovered some put not all – Realized volatility has come down substantially but is still pretty high • Selling short term NEAR THE MONEY PUTS could still be problematic – Remember we don’t want to sell into a buzz saw – The implied volatility is pretty nice so we look at moving the duration out

AAPL has recovered somewhat

AAPL options and short puts

Short put spread • Implied Volatility- IV is declining but the stock has not recovered – Adjust the short put with a put spread – Move out the duration – What is the yield? 1% per month on the all in margin • This is still ugly but a little more protection might be prudent

Short put spread • Implied Volatility- IV is declining but the stock has not recovered – Adjust the short put with a put spread – Move out the duration – What is the yield? • This is still ugly but a little more protection might be prudent

SPY recent history was very volatile

1 month SPY put spreads yield 1%

SPY put spread analysis • SPY Mar 15 270/254 put spread yields 1% per month right now or better AND we need that much to outperform SPY – Realized vol is lower now What would a VIX or VXX call Do in Nov 16, 2018?

VIX calls are a partial hedge On Nov 16 th 2018 the SPY Dec 21 260/ 273 Yielded over $3 or better than 1% A VIX call only hedged part of those dollar By Dec 21 expiration VIX was 18. 13

Offense • Offensive positions are a little more aggressive types of put selling by nature Consist of Diagonal put spreads or broken wing butterflies These positions have some near term gamma The difference between the two is downside

Ratio put or Broken Wing Butterfly For a higher IV that is moving • Normally after some announcement Realized volatility- looking for a spike in 10 day RV -RV is at the higher end of the range but is starting to decline (rest for a day or two)

Ratio put • Implied volatility- the IV is in the higher end for this trade and moving lower • RV is going to be higher than the IV in the short term • Flip the trade to a BWB if RV has the chance to stay high • Nice skew is great if you can get it • Work 1 Standard Deviation out on the long strike and short strike

NVDA is too volatile …the one way up is ugly for call sellers

Pricing out NVDA

YNDX • https: //www. businessinsider. com/russiayandex-self-driving-car-review-pictures-20191 • Take the news and create a position – Early or not early? • Russian Internet Stock with Ridesharing – Not a stock investment but maybe we can create an option trade

YNDX

Using Diagonal Put spreads • YNDX is something I might want to own – A diagonal put spread is fine for that – This is a more “offensive” TRADE • WE KEEP THE CREDIT • OR DECIDE HOW TO TAKE DELIVERY – Let’s walk through it

YNDX

The Vol Newsletter

The VN strategy • Long VIX or VXXB calls in backwardation • Long VIX or VXXB puts in contango – Both of these strategies in tandem can help finance protective SPY puts

Wrapping up • Using Options to replace stock should generate better returns for less risk • Using volatility to set up the long term trade can help • Do you play offense or defense • Pick risk you want to control through position

Thank you for attending! mark@optionpit. com andrew@optionpit. com 1(888) Trade-01