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Last week’s discussion on the “Robinhood” options trades was popular with traders, many of whom wanted to know how to construct a trade for crazy underlying price movement and high implied volatility.
Options market makers generally won’t draw a line in the sand when it comes to selling options. When the public starts buying up options, the market makers will raise their implied volatility inputs and keep selling them at higher and higher prices. In fact, it’s precisely when vols reach extreme highs that market makers find their trading most profitable.
They're selling at prices that make it nearly impossible for a buyer to make a profit.
In situations in which you think the actual price movements in a stock are unlikely to match the inflated implied volatilities you see in the market, the natural impulse might be for you to sell options as well. Simply selling calls, puts or a straddle (selling one of each with the same strike and expiration date) comes with significant risk, however. If the stock does in fact make a big move, you can lose a multiple of what you stood to gain. In the case of naked short calls, the risk is technically infinite.
You never want to enter a trade with infinite risk, no matter how good you think the odds of winning might be.
An iron condor involves selling a straddle and buying an out-of-the-money call and put, which mitigate the risk. The at-the-money options have more vega (sensitivity to a change in implied volatilities) and theta (sensitivity to the passage of time) than the options you purchased, so if implied volatility declines and/or time passes without a big move in the underlying, you’ll make a profit on the trade.
One thing I’ve been noticing lately in the options of the most volatile “reddit-hype” type stocks is that some of the straddles are trading at such high prices that you don’t even have to buy the lower strike put.
These opportunities don’t come around very often – but when they do – they can be an opportunity to make some low-risk profits. They’re not home-run trades. In fact they’re the opposite; when the retail trading crowd is swinging for the fences by buying longshot options at high prices, you can hit a high-percentage base hit.
During the first huge runup in shares of GameStop (GME - Free Report) , implied options volatilities got up into the 600-800% range. That’s where things get really crazy. At the end of January, you could sell the February 320 strike straddle for more than $330 when there were only about three weeks remaining until expiration.
Selling that straddle meant that you expect the stock to move less than $330 over the next three weeks – and you don’t even have to worry at all about a sharp move to the downside. Even if the share price went all the way to zero, you’d still have a profit of $10.
Obviously, the risk is all to the upside. You have a great deal of cushion here; you don’t start losing any money until the price is above $650. After that, however, it gets ugly. As unlikely as you might think it is for a stock that was worth less than $20/share at the beginning of the year to reach that kind of price, you still have exposure to crippling losses.
So you also need to buy an upside call. The highest call listed had a strike of 800 and was trading around $40. That’s awfully expensive for an option that’s so far out of the money, but it’s also a lot less in total dollar terms than the options you sold. If you buy one, you limit your upside risk so you can sleep at night.
Now after that purchase, you have a very small amount of downside risk. You lose a if the shares end up below $20, but even at zero, $20 is your maximum loss. You have more risk on the upside. You lose money between $610 and $800 with a maximum loss of $190. That’s still significant - $19,000 per spread – but it’s only about 2/3 of what you stood to gain as your maximum profit, $29,000.
Rather than simply waiting for expiration however, you can watch the market and wait for an opportunity to buy back your short options at a lower price. If the big move in the stock never materializes and the small buyers either lose interest or run out of money, those options you sold are likely to lose value quickly.
Personally, I don’t wait for them to be worth zero. If they move significantly my way, I’ll cover for a profit. You can also buy back the put by itself, and then separately buy the 320 call or the 320-800 call spread.
No matter how you end up closing the trade, you took sensible and measured risk and put yourself in a position to profit from the increased demand for options.
-Dave
David Borun runs the Zacks Marijuana Innovators Portfolio as well as the Black Box Trading Service and the Short Sell List Trading Service. Want to see more articles from this author? Scroll up to the top of this article and click the “+Follow” button to get an email each time a new article is published.
Interested in strategies with profit potential even in declining markets? Maybe our Short Sell List Trader service is for you.
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Selling Options Responsibly in the Reddit Stocks
Last week’s discussion on the “Robinhood” options trades was popular with traders, many of whom wanted to know how to construct a trade for crazy underlying price movement and high implied volatility.
Options market makers generally won’t draw a line in the sand when it comes to selling options. When the public starts buying up options, the market makers will raise their implied volatility inputs and keep selling them at higher and higher prices. In fact, it’s precisely when vols reach extreme highs that market makers find their trading most profitable.
They're selling at prices that make it nearly impossible for a buyer to make a profit.
In situations in which you think the actual price movements in a stock are unlikely to match the inflated implied volatilities you see in the market, the natural impulse might be for you to sell options as well. Simply selling calls, puts or a straddle (selling one of each with the same strike and expiration date) comes with significant risk, however. If the stock does in fact make a big move, you can lose a multiple of what you stood to gain. In the case of naked short calls, the risk is technically infinite.
You never want to enter a trade with infinite risk, no matter how good you think the odds of winning might be.
An iron condor involves selling a straddle and buying an out-of-the-money call and put, which mitigate the risk. The at-the-money options have more vega (sensitivity to a change in implied volatilities) and theta (sensitivity to the passage of time) than the options you purchased, so if implied volatility declines and/or time passes without a big move in the underlying, you’ll make a profit on the trade.
One thing I’ve been noticing lately in the options of the most volatile “reddit-hype” type stocks is that some of the straddles are trading at such high prices that you don’t even have to buy the lower strike put.
These opportunities don’t come around very often – but when they do – they can be an opportunity to make some low-risk profits. They’re not home-run trades. In fact they’re the opposite; when the retail trading crowd is swinging for the fences by buying longshot options at high prices, you can hit a high-percentage base hit.
During the first huge runup in shares of GameStop (GME - Free Report) , implied options volatilities got up into the 600-800% range. That’s where things get really crazy. At the end of January, you could sell the February 320 strike straddle for more than $330 when there were only about three weeks remaining until expiration.
Selling that straddle meant that you expect the stock to move less than $330 over the next three weeks – and you don’t even have to worry at all about a sharp move to the downside. Even if the share price went all the way to zero, you’d still have a profit of $10.
Obviously, the risk is all to the upside. You have a great deal of cushion here; you don’t start losing any money until the price is above $650. After that, however, it gets ugly. As unlikely as you might think it is for a stock that was worth less than $20/share at the beginning of the year to reach that kind of price, you still have exposure to crippling losses.
So you also need to buy an upside call. The highest call listed had a strike of 800 and was trading around $40. That’s awfully expensive for an option that’s so far out of the money, but it’s also a lot less in total dollar terms than the options you sold. If you buy one, you limit your upside risk so you can sleep at night.
Now after that purchase, you have a very small amount of downside risk. You lose a if the shares end up below $20, but even at zero, $20 is your maximum loss. You have more risk on the upside. You lose money between $610 and $800 with a maximum loss of $190. That’s still significant - $19,000 per spread – but it’s only about 2/3 of what you stood to gain as your maximum profit, $29,000.
Rather than simply waiting for expiration however, you can watch the market and wait for an opportunity to buy back your short options at a lower price. If the big move in the stock never materializes and the small buyers either lose interest or run out of money, those options you sold are likely to lose value quickly.
Personally, I don’t wait for them to be worth zero. If they move significantly my way, I’ll cover for a profit. You can also buy back the put by itself, and then separately buy the 320 call or the 320-800 call spread.
No matter how you end up closing the trade, you took sensible and measured risk and put yourself in a position to profit from the increased demand for options.
-Dave
David Borun runs the Zacks Marijuana Innovators Portfolio as well as the Black Box Trading Service and the Short Sell List Trading Service. Want to see more articles from this author? Scroll up to the top of this article and click the “+Follow” button to get an email each time a new article is published.
Interested in strategies with profit potential even in declining markets? Maybe our Short Sell List Trader service is for you.