This is my first attempt at blogging. Before I get to my post, I feel I should try to explain my motivation for finally starting. I have always wanted to produce my own content online and be subjected to peer review and criticisms – I believe this is how I will grow as a person and as a trader. I am a long time user of content on the internet and twitter – especially stocktwits and the great trading community they have there – and have benefitted enormously from reading the content available. This will be my first attempt to produce something which will hopefully bring value added to those that do read it. Finally I must admit, what it really took was a kick in the ass from a friend – thank you @tburts. Now onto my post.
I am fairly new to trading with options, and so far have had mixed success. What first drew me to options was not only the wide range of trades available using options but also the thought that I know my exact downside risk in any trade. I have learned a fair amount about what not to do in a short period of time and the markets are not a gentile teacher – but nothing in this world is free and I love every minute of it.
What intrigues me more than anything right now when it comes to options can be summed up in three words: volatility is cheap. To put this in perspective, here is a chart of the VIX for the last 10 years.
On the graph we can see quite clearly that volatility is declining. The upper line is drawn at 16, the lower at 9. The 16 level has been acting as ‘support’ for the VIX, which can be better seen in this 6 month chart of the VIX, where we can see that volatility is on the decline.
We can see here that the VIX has tested this 16 level three times and it has acted as support. In essence when the VIX declines below 16, volatility has picked up in the short term which more often than not has led to corrections.
Now back to options. While I do not understand fully how volatility factors into the price of options, it is sufficient to say that when volatility – or expectations of volatility – is low this makes options relatively cheaper than when it is not.
Because volatility is cheap right now, I have been buying options to hedge existing positions, as well as buying long out calls on some stocks that I wish participate in. The way I see it, it is a win win. If volatility does pick up and we correct, I am hedged and the value of my call options increases with volatility should we resume our upward momentum. If volatility falls below 16 and enters the 9-16 range, we continue to melt up and I see returns in my long term calls. In essence, I like sales, and volatility is historically cheap right now.
Because this is a learning experience for me, feedback would be very helpful. I am not delicate, so feel free to be blunt.