Papale on Inflated Stock Options

Just like Miley Cyrus this just won’t go away.  This whole deflate gate thing just keeps showing up.  It just amazes me how much mental energy, time and money has been spent on the PSI of a football in a game where the Pats beat the Colts by 38.  Anyway old news.  It seems this in fact may go away after all.  The judge sided with Tom Brady last week and hopefully finally put this to rest.  Now what to do with Miley.

Markets continue to have pretty big moves.  VIX right now sits around 25, still above the range it spent most of the last year or so in, which was between 10 and 20.  But last week it spiked up to above 50.  For those who sell puts and calls against stock the last week or so has been a pretty good environment.  On the selloff days we were able to dip our toe in the water and sell puts at much higher prices than we have seen in a while.

For example AAPL 95 puts were trading around $6, which gives the seller the opportunity to buy AAPL below $90 should they get assigned.  Now granted that was right near the open on Monday a week ago when the market dropped by over 1000.  But even as things came back prices were still high.  Calls were high too.  MSFT Sep 43 calls were trading over $1 with the stock around $41.  Wednesday, the stock closed at $43.35 and the calls closed at $1.25.  Stock rallied $2.35 and the calls went up $0.25.  That hissing noise in the background is the sound of volatility coming out of options.

Now of course stocks could have kept going down.  But if you are trying for high probability setups, this is the environment to play in whether you are doing a put/call strategy as a trade or as a portfolio management approach.  For the portfolio builder, know where you are happy buying the stock and sell inflated puts to get that price point.  If you already own the stock, roll calls when given the opportunity.  But be aware that even when vols fall in rising markets, if stocks rally too much you can miss on any rallies above your short call strike.

And one last point.  Your P/L may seem a bit lower than expected during much of the life of a trade like this.  If this happens it could be due to vols falling slower than expected.  Remember all extrinsic value must go to 0 at expiration so be patient.

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