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Vertical Spread Trading: Implied Volatility & Profitability

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Implied volatility plays a major role in profitability when trading vertical spreads. In this video, you'll learn how changes in implied volatility can help or hurt the performance of the four vertical spread strategies. More specifically, you'll learn why you want implied volatility to decrease when the stock price is moving in favor of your spread, and why you want implied volatility to increase when the stock moves against you. Many options educators teach this concept incorrectly, which is why correctly understanding this topic is so important. FULL GUIDE: https://www.projectoption.com/vertical-spreads-explained/ ==== RESOURCES ==== Trade with tastyworks (& Get a Free Course): https://www.projectoption.com/tastyworks/ Our Options Trading Courses: https://www.projectoption.com/options-trading-courses/ ==== FAVORITE OPTIONS TRADING BOOKS ==== How to Price & Trade Options: https://amzn.to/2FqsPmn Option Volatility and Pricing: https://amzn.to/2SU6f8K
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Text Comments (17)
Jerry Nix (14 days ago)
I've heard alot that you want to sell if the IV is over 50 and buy when IV is as low as possible up to 50, is that correct?
Jerry Nix (12 days ago)
+projectoption thank you
projectoption (12 days ago)
Hi Jerry, That's a rule tastytrade follows but I personally don't. They are looking at IV "rank," which is where the current implied volatility is relative to the highest and lowest readings over the past year. I personally employ strategies that I trade year-round regardless of IV.
Harry Tanumiharja (6 months ago)
I thought we should trade for high IV stocks in order to make a profit as high IV moves the stock price?
projectoption (6 months ago)
Not necessarily. Stocks with high implied volatility (option prices are higher relative to stocks with lower implied volatility) are very volatile, which is exactly why their option prices are high. High volatility in the stock price does not make it easier to profit from trading options on the stock. A lot of options trading research has shown that selling options on stocks with high implied volatility has historically worked out in most cases, but keep in mind the options are 'expensive' for a reason (the stock's high volatility). I hope this helps! -Chris
Daniel Penchev (11 months ago)
If you buy low and sell higher extrinsic value makes logical sense that your Bull Call spread will cost more,but in fact Chris show us that this is not the case.. Thank you very much for all educational videos you are making!
projectoption (11 months ago)
Glad you liked the video. Thank you for leaving an awesome comment and you're welcome! -Chris
Maria Popek (1 year ago)
thanks for helping clarify such an important subject
projectoption (1 year ago)
You're welcome, Maria! Thanks for the comment!
PK (1 year ago)
Chris, let me see if I understand this video correctly: Suppose you short an underlying by shorting its OTM call vertical (e.g., shorting 110C and long 120C while the underlying is trading at 100), and then the underlying price tumbles, which probably causes IV to spike. On one hand, the direction of the underlying price is in your favor. On the other hand, however, the spiking of IV dampen your directional gain. Is my understanding correct? If so, how should I short an underlying if I want its IV changes to work for my favorable direction?
projectoption (1 year ago)
Pengkui, Fantastic question. The quick answer is that if the stock price decrease is significant, then the increase in IV shouldn't really matter too much. However, it's still ideal to have all factors working in your favor if you're correct about the stock price decreasing. With that said, you need a negative delta and positive vega strategy. The two strategies I can think of that fit these criteria are: 1) Long Put 2) Put Backspread (Sell 1 Put, Buy 2 Puts at a lower strike) You'll notice that I didn't say a long put spread, and that's because a long put spread will actually become a negative vega strategy as the stock price moves closer and closer to your short put's strike price. So, if you get a severe stock price decrease through your put strikes and an increase in IV, you'll be worse off than if you got the same sell-off with a decrease in IV. BACKSPREAD - If you don't want the long put exposure, you could try a put backspread and try to structure the trade for a small debit or a tiny credit. The benefit of this strategy is that the loss will be minimal if the stock price increases against you. However, you may have more loss potential than simply buying a put if the stock price falls slowly over time and settles near your long put's strike price. There are many approaches you can take, but these two strategies are the first that come to mind when considering your situation. I hope this helps! Please let me know if you have any follow-up questions. -Chris
traktorist2007 (1 year ago)
Great work! Could you provide some lessons about adjustment verticals spreads?
projectoption (1 year ago)
I can definitely put together videos for that topic in the future. -Chris
David Kendall (1 year ago)
Since I'm an analytical sort of guy, I enjoyed this video, and the video definitely demonstrates Chris's mastery of options trading and strategies. Chris is the best. IV is something of a catch phrase in options trading jargon. But in the lived world, once a trade is placed, IV become next to useless to think about, since there isn't anything a trader can do to influence IV. IV is an important criterion when a trade is placed. But after the trade is placed, why think about IV at all? Nothing to be done for it. Changes in IV will either hurt the trade or help the trade, but nothing the trader can do will affect IV.
projectoption (1 year ago)
David, First of all, thanks so much for the kind comment. Second, you're absolutely right about not having any control over IV (or the stock price for that matter). However, it's important to understand what you want to happen when placing trades, as that will help determine "better" entry points. For example, many buy call/put spreads in low IV thinking an increase in IV will help them. However, it's actually more strategic to buy spreads in higher IV environments because an IV contraction combined with the correct directional movement in the stock price will yield more profits than just a directional movement and no change (or increase) in implied volatility. I hope this helps clear up why I talked about "what you want to happen" when trading vertical spreads. -Chris
122333444455555 (1 year ago)
Nice to see the impact of a vol spike on a spread broken down so clearly, thanks for the explanation!
projectoption (1 year ago)
You're welcome, Richard! -Chris

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