In this article wed like to explain adjustment beliefs which can be practical in running an options account. Thisindividual strategy can be practical to each and every type of option spread such as the Credit Spread, Iron Butterflies, Iron Condors, Double Diagonals, as well as others.
As this is being written in October of 2008 the VIX is ashigh as its been. Look at a 5 year chart and see where we are. This level of volatility has made options quite expensive. Before we make any adjustments to ourportfolios, we always think about the volatility. Where is itnow and where is it going? Should we be buying or selling options at this moment?
A very common mistake that option traders make is buying or selling options at the wrong time. If we buyoptions when the volatility is at a high, we are entering a trade with odds against us. Option traders that do this dont realize why their options lose value so fast. Everyoption trading adjustment should be made by thinking of the option Greeks and volatility. We really need tounderstand these fundamentals to succeed in the options market.
A TYPICAL OPTION POSITION THAT MIGHT NEED AN ADJUSTMENT
For example, we have on a Butterfly spread and the market has been up-trending for a few days. In this casewe might need to make an adjustment on the Butterfly or possibly on our whole portfolio. Options trading requires some management or we can take on great amounts of risk. So, if this is the situation, wed be looking at adjustment ideas with IV in mind. Well study our pricechart and also the IV chart. Perhaps well find that the IV is on support now, and it looks like its going to rise again.
There are many option strategies and morphingconcepts, so how can we make a good decision on what to do in this case? A critical step in the decision making is graphing the current volatility inside the options market.We usually use the VIX and RVX. Is the volatility bottomedand increasing? Is it at a peak and coming back down? Is it barely moving? What is happening in the options market and where is the volatility in relationship to its history?We additionally need to study the technical analysis of our traded asset. Where is the price headed? We have to comprehend Vega and the other option Greeks to accomplish high probability changes to our positions. Intodays example, if the volatility prediction is up, it would make sense to add some positive Vega to our portfolio.
There is really an unlimited number of ways to create a positive Vega position, but the most common positiveVega spreads are Debit Spreads, Short Butterflies, BrokenWing Butterflies (OTM), Short Condors and Calendars. In our mentoring course we discuss option strategies and adjustments in detail.
To summarize, when your option trades come to anadjustment point, always think about the IV of your asset. If you can make decisions based on volatility, direction, and time, then your option tradingskills will be much better. Its the little things like this that make a difference at the end of the year.