Today I will cover two topics.? The first is a week late as I covered this last week on CBOE TV with Angie Miles.? But, it is a valuable lesson and worth the look.?
Pretty much every month, I sell SPX strangles.? Unlike when I sell individual equities, I am reasonably ambivalent to the IV percentile of the market when selling.? This is because the VIX, which is a derivative of the SPX options, can stay low for very long periods of time (think years).? During these periods, the historical, or realized, volatility is often very low.? In fact, the gap between the IV and the HV is often at its greatest during periods of low volatility.? So, these are good times to be short premium in the index.? But, I am also mindful of the increased risk I am taking should the market suddenly turn down and the VIX should pop as a result.? Today, we use recent events to illustrate this.
Back on January 8th, I sold the Feb SPX 90% Probability of expiring OTM strangle.? Feb had 43 days to expiration and the VIX was trading for just under 13.? I sell the put and call that each have a 95% probability of expiring out of the money.? For this cycle, the put was $200 under the SPX and the call was $95 above the SPX.? I received $3.55 for the strangle.? As you know, we had a bit of a sell off of late and on Feb.5th the VIX was trading for just under 20.? There were 43 days to March expiration so it was time to sell my March strangle.? This time, using the same probabilities, I was able to sell the put $300 below the SPX, the call $130 above the SPX and receive $4.68.? So, instead of a $295 wide strangle for $3.55, I was able to sell a $430 wide strangle for $4.68!? And, using the then current IVs, the probabilities were the same.? That is the power of implied volatility in the market. This also illustrates why we lower our expectations of returns for our accounts when IV is low.??
Knowing I have increased risk often leads me to add creative trades with low risk that protect my portfolio should the volatility suddenly rise.? I have spoken of these in the past.? My next topic is just such a trade.
HES is a large oil and gas company that has a beta of 1.12.? It moves with the overall market and, of late, has mirrored the S&Ps pretty closely.? HES is trading in the 10th percentile of its one-year IV range and is one of the cheaper stocks on the board in that regard.? Someone came in yesterday and purchased 12,000 March $75 puts with the stock at $77.? The bulk of the puts traded for around $1.62.? This trade has a breakeven price at $73.38, which is below HES?s lowest price since August.? But, with HES so highly correlated with the SPX, this is actually a pretty smart defensive trade for someone?s portfolio.? Why buy the SPY in its 40% percentile when you can buy a highly correlated stock in its 10th percentile?? If the market gets dicey, these puts should benefit both from its directional bias and from the IV increase we would likely experience.? Though it is a bit expensive for my taste (on an absolute basis), this is one of those creative ways of adding protection to ones portfolio.