Low-Volatility Stocks, Put Skew And The Consequences Of Low IV

Low-Volatility Stocks: Fewer Drawdowns, Smaller Price Fluctuations

I’ve learned three things last month: manage your winners no matter what (if you don’t, the relationship between risk and reward just worsens), diversify into more underlyings in different industries, focus on attractive underlyings rather than absolute premium and ROIC (Return On Invested Capital, thus premium/buying power reducation) and reduce your contract size if you have to roll the untested side… The following research pieces give us insight into the powerful statistical evidence of selling wide strangles, diversifying into several industries and why low-beta stocks are very attractive from a premium seller standpoint.

The new watchlist of 25-30 stocks I’ve composed just a moment ago, is made up of low-beta stocks that show a high IV/Hist. Vol. ratio. To put another way, their realized volatility is a lot lower than what the options prices indicate. This translates into a standard deviation of 9.6% versus 12.50% for the S&P-500. Their correlation with the US Market is 0.83, but by selling delta-neutral strangles we take that number to a whole different level: 0.15 or less.

You can also combine the SPLV tracker (low-volatility index fund) with covered call writing on the SPY tracker. You can implement this strategy easily and get a much more attractive risk/reward ratio. I've already written an in-depth article on this approach. You can re-read it HERE.

The drawdowns are considerably lower which is just amazing considering the sell-off of Q4 2018. Fewer drawdowns mean that our put strikes are tested less frequently.

Put Skew

Additionally, this is a crucial aspect for premium sellers as puts are often priced with elevated implied volatility and thus more expensive than the calls. If you can minimize the impact of drawdowns, you should capture much more of the put premium relative to the call premium. So, looking for low-beta stocks with noticeable put skew bears fruit in the long run. This has proven to be a very successful strategy over the past years as you generated higher profits with less volatility. The downside to this approach? You have less occurrences if you wait for these events. Below you find the screenshot of NEE and its corresponding IVs for puts and calls. The wider the spread, the richer the put premia relative to calls and it’s just another factor in creating optimal conditions for our option selling portfolio. This is interesting as you have the same deltas for puts and calls (10-delta strangles for example), but you benefit more from an uptrend than a downturn, which has been the case for low-beta stocks for good part of the past 20 years.

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