Effective Options Selling During Volatility Spikes
By:Kai Zeng
Implied volatility (IV) is a critical concept that behaves differently from the price movement of stocks or equities. Unlike stock prices, which often follow trends or patterns, IV tends to spike to very high levels and then quickly revert to the average. After this reversion, it typically stays in a low range for an extended period. This unique behavior of IV can present opportunities and risks for options traders.
Because of its distinctive behavior, implied volatility exhibits a much wider range of daily price changes compared to stocks. This increased fluctuation means that large, unexpected moves are more likely when trading options. Because of this, traders can consider strategies specifically designed to capitalize on these spikes in IV.
One such strategy involves selling options when implied volatility spikes. Historical data suggests that selling options during these high-IV environments can lead to significant profits. As an example, consider the SPY Exchange-Traded Fund, which tracks the S&P 500. By selling SPY 45 days to expiration (DTE) 20 delta (Δ) strangles after observing significant percentage increases in the VIX (a measure of market volatility), traders could enhance their performance.
Our analysis found the larger the increase in the VIX, the better the performance of the sold options, leading to higher profits and reduced volatility. The VIX, often referred to as the "fear gauge," measures market expectations of near-term volatility and tends to spike during market turmoil. For traders, this means periods of high VIX readings could offer lucrative opportunities for selling options.
Two key takeaways from this analysis:
First, implied volatility, such as the VIX, can make outsized moves but generally reverts to the mean and stays low for extended periods.
Second, selling options when there is a spike in implied volatility can boost returns and reduce risk.
Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
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Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.