What to do about volatility?That is the question.Has it fallen far enough to tempt you to own positions that are long vega (calendar spreads, diagonals, naked long puts and/or calls etc.)
It doesn’t tempt me, and I’m going to continue to trade iron condor positions (with negative vega) which do well in periods of declining IV and vice versa.But, I’m taking it gently and am trading fewer contracts than last year.I am not going to gamble that the huge market volatility of 2008 is behind us – and safety comes first.
Recently, Adam at Daily Options Report has been pointing out that the market has been less volatile* than option implied volatility (IV) has been predicting.When that’s true, the probability of success when trading vega is on the side of the seller, not the buyer.From my perspective, buying iron condors has been a winning strategy for 2009.
*This is not complicated:Assume the IV of a stock or index is 50.This means that options are priced so that if the future volatility of that stock or index turns out to be 50, then the options are fairly priced.Recently, stocks are moving by less than IV predicts and option buyers are not getting ‘their money’s worth’ of market movement.Thus, they are paying too much for the options.
