For this post I’m going to talk a little bit about a different strategy that goes long in a nondirectional path based on the volatility level of the instrument in question.
For options trading, the price of the options depends on again a) the delta or the change in the underlying, b) theta or the inherent time decay of the option, and c) the supply and demand on the option contract itself which is estimated by the volatility of the underlying.
In a low volatility environment, especially, buying long-term calls and puts can be very attractive because of the inherently low prices of the option contracts. Hedging half of the position with a short strangle can amplify the benefits of the long strangle.
In high volatility environments, buying a straddle can be fool’s gold, where an inexperienced trader might see tremendous volatility, say in Tesla, and conclude buying the put and call at once would be a good deal. Or likewise buying puts on VXX after a large volatility spike. Instead, this is a classic way for market makers and institutional counterparties to suck money from a customer by the sudden drop in the value of the options contract several weeks later with collapse in volatility. Being aware of this danger is very helpful to the retail trader.
In high volatility environments, the customer seeking to have no directional risk can instead turn to the reverse iron condor. In the Reverse Iron Condor (RIC), the effect of volatility is heavily dampened by using essentially two debit spreads. Time decay is also attenuated by using the spreads. The RIC’s benefit is most seen during sustained high volatility, such as what is seen pre-earnings or during current market conditions.
More posts to come on some trade ideas with the RIC.
