Thoughts on volatility and option premium. Pay attention to the following statement.
Buying calls after the market moves hard to the downside is a very difficult way to make money
Many people think this is a good time to buy calls when the market drops this fast, if they believe the market will go up in the near to mid term trading periods. I dont believe this is the best strategy. With volatility sitting at 35%, calls are very expensive right now. Even if you buy calls and the instrument rises, then voltility will drop and so will option premium. This means your calls will likely not rise and my even go down in price. Right now the calls are very expensive and wont start to go down in value until the market rallies. I know that sounds contradictory but if you watch the premium on your favorite stocks if we get a rally, you will see it decrease.
The way to take advantage of the current high voltility levels is instead of buying a calls, buy call spreads, sell put spreads, or do both. For every penny of premium you buy in the money, you sell a penny of premium out of the money. What happens are that your premiums are offset, you get very tight spread market, so if the market moves up, you get a penny for penny move with the underlying instrument which is awesome, because you have no premium loss exposure. This is how premium erosion works.
If you are directional trader-Look for vertical spreads that fits your criteria of expected movement.
This is a really good time to place non directional trades with implied volatility so high. You can put on vertical positions that are much further away than at the money strikes, than under normal market conditions. Short term iron condors with larger spreads are a great way to take advantage of quick market drops.
Another important consideration is that when you have high implied volatility, you can put on smaller position sizes than you normally trade and still get the same type of return. I mentioned here last week that I was reducing my position sizes considerably. This is a great way to reduce your risk.
